BankruptcyBASICS

Administrative Officeof the United States Courts

BankruptcyBASICS

Bankruptcy Judges Division

Administrative Officeof the United States Courts

November 2011Revised Third Edition

While the information presented is accurate as of the date of publication, it should not be citedor relied upon as legal authority. It should not be used as a substitute for reference to theUnited States Bankruptcy Code (title 11, United States Code) and the Federal Rules ofBankruptcy Procedure, both of which may be reviewed at local law libraries, or to local rules ofpractice adopted by each bankruptcy court. Finally, this publication should not substitute forthe advice of competent legal counsel.

Table ofCONTENTS

Introduction 5

The Discharge in Bankruptcy 9

Chapter 7. Liquidation Under the Bankruptcy Code 14

Chapter 13. Individual Debt Adjustment 22

Chapter 11. Reorganization Under the Bankruptcy Code 29

Chapter 12. Family Farmer or Family Fisherman Bankruptcy 43

Chapter 9. Municipality Bankruptcy 49

Chapter 15. Ancillary and Other Cross-Border Cases 57

SCRA. Servicemembers’ Civil Relief Act 60

SIPA. Securities Investor Protection Act 64

Bankruptcy Terminology 71

Bankruptcy BasicsA Publication ofthe Bankruptcy Judges Division

Introduction

Bankruptcy Basics is designed to providebasic information to debtors, creditors, courtpersonnel, the media, and the general publicon different aspects of the federal bankruptcylaws. It also provides individuals who may beconsidering bankruptcy with a basicexplanation of the different chapters underwhich a bankruptcy case may be filed and toanswer some of the most commonly askedquestions about the bankruptcy process.

Bankruptcy Basics provides generalinformation only. While every effort has beenmade to ensure that the information containedin it is accurate as of the date of publication, itis not a full and authoritative statement of thelaw on any particular topic. The informationpresented in this publication should not becited or relied upon as legal authority andshould not be used as a substitute forreference to the United States BankruptcyCode (title 11, United States Code) and theFederal Rules of Bankruptcy Procedure.

Most importantly, Bankruptcy Basics shouldnot substitute for the advice of competentlegal counsel or a financial expert. Neither theBankruptcy Judges Division nor theAdministrative Office of the United StatesCourts can provide legal or financial advice.Such advice may be obtained from acompetent attorney, accountant, or financialadviser.

The Process

Article I, Section 8, of the United StatesConstitution authorizes Congress to enact“uniform Laws on the subject ofBankruptcies.” Under this grant of authority,Congress enacted the “Bankruptcy Code” in1978. The Bankruptcy Code, which iscodified as title 11 of the United States Code,has been amended several times since itsenactment. It is the uniform federal law thatgoverns all bankruptcy cases.

The procedural aspects of the bankruptcyprocess are governed by the Federal Rules ofBankruptcy Procedure (often called the“Bankruptcy Rules”) and local rules of eachbankruptcy court. The Bankruptcy Rulescontain a set of official forms for use inbankruptcy cases. The Bankruptcy Code andBankruptcy Rules (and local rules) set forththe formal legal procedures for dealing withthe debt problems of individuals andbusinesses.

There is a bankruptcy court for each judicialdistrict in the country. Each state has one ormore districts. There are 90 bankruptcydistricts across the country. The bankruptcycourts generally have their own clerk’soffices.

The court official with decision-makingpower over federal bankruptcy cases is theUnited States bankruptcy judge, a judicialofficer of the United States district court. Thebankruptcy judge may decide any matterconnected with a bankruptcy case, such as

6eligibility to file or whether a debtor shouldreceive a discharge of debts. Much of thebankruptcy process is administrative,however, and is conducted away from thecourthouse. In cases under chapters 7, 12, or13, and sometimes in chapter 11 cases, thisadministrative process is carried out by atrustee who is appointed to oversee the case.

A debtor’s involvement with the bankruptcyjudge is usually very limited. A typicalchapter 7 debtor will not appear in court andwill not see the bankruptcy judge unless anobjection is raised in the case. A chapter 13debtor may only have to appear before thebankruptcy judge at a plan confirmationhearing. Usually, the only formal proceedingat which a debtor must appear is the meetingof creditors, which is usually held at theoffices of the U.S. trustee. This meeting isinformally called a “341 meeting” becausesection 341 of the Bankruptcy Code requiresthat the debtor attend this meeting so thatcreditors can question the debtor about debtsand property.

A fundamental goal of the federal bankruptcylaws enacted by Congress is to give debtors afinancial “fresh start” from burdensome debts.The Supreme Court made this point about thepurpose of the bankruptcy law in a 1934decision:

[I]t gives to the honest but unfortunatedebtor…a new opportunity in life and a clearfield for future effort, unhampered by thepressure and discouragement of preexistingdebt.

Local Loan Co. v. Hunt, 292 U.S. 234, 244(1934). This goal is accomplished through thebankruptcy discharge, which releases debtorsfrom personal liability from specific debts and

prohibits creditors from ever taking any actionagainst the debtor to collect those debts. Thispublication describes the bankruptcydischarge in a question and answer format,discussing the timing of the discharge, thescope of the discharge (what debts aredischarged and what debts are notdischarged), objections to discharge, andrevocation of the discharge. It also describeswhat a debtor can do if a creditor attempts tocollect a discharged debt after the bankruptcycase is concluded.

Six basic types of bankruptcy cases areprovided for under the Bankruptcy Code, eachof which is discussed in this publication. Thecases are traditionally given the names of thechapters that describe them.

Chapter 7, entitled Liquidation, contemplatesan orderly, court-supervised procedure bywhich a trustee takes over the assets of thedebtor’s estate, reduces them to cash, andmakes distributions to creditors, subject to thedebtor’s right to retain certain exemptproperty and the rights of secured creditors.Because there is usually little or nononexempt property in most chapter 7 cases,there may not be an actual liquidation of thedebtor’s assets. These cases are called“no-asset cases.” A creditor holding anunsecured claim will get a distribution fromthe bankruptcy estate only if the case is anasset case and the creditor files a proof ofclaim with the bankruptcy court. In mostchapter 7 cases, if the debtor is an individual,he or she receives a discharge that releaseshim or her from personal liability for certaindischargeable debts. The debtor normallyreceives a discharge just a few months afterthe petition is filed. Amendments to theBankruptcy Code enacted in to theBankruptcy Abuse Prevention and Consumer

7Protection Act of 2005 require the applicationof a “means test” to determine whetherindividual consumer debtors qualify for reliefunder chapter 7. If such a debtor’s income isin excess of certain thresholds, the debtor maynot be eligible for chapter 7 relief.

Chapter 13, entitled Adjustment of Debts ofan Individual With Regular Income, isdesigned for an individual debtor who has aregular source of income. Chapter 13 is oftenpreferable to chapter 7 because it enables thedebtor to keep a valuable asset, such as ahouse, and because it allows the debtor topropose a “plan” to repay creditors over time– usually three to five years. Chapter 13 isalso used by consumer debtors who do notqualify for chapter 7 relief under the meanstest. At a confirmation hearing, the courteither approves or disapproves the debtor’srepayment plan, depending on whether itmeets the Bankruptcy Code’s requirements forconfirmation. Chapter 13 is very differentfrom chapter 7 since the chapter 13 debtorusually remains in possession of the propertyof the estate and makes payments to creditors,through the trustee, based on the debtor’santicipated income over the life of the plan.Unlike chapter 7, the debtor does not receivean immediate discharge of debts. The debtormust complete the payments required underthe plan before the discharge is received. Thedebtor is protected from lawsuits,garnishments, and other creditor actions whilethe plan is in effect. The discharge is alsosomewhat broader (i.e., more debts areeliminated) under chapter 13 than thedischarge under chapter 7.

Chapter 11, entitled Reorganization,ordinarily is used by commercial enterprisesthat desire to continue operating a businessand repay creditors concurrently through a

court-approved plan of reorganization. Thechapter 11 debtor usually has the exclusiveright to file a plan of reorganization for thefirst 120 days after it files the case and mustprovide creditors with a disclosure statementcontaining information adequate to enablecreditors to evaluate the plan. The courtultimately approves (confirms) or disapprovesthe plan of reorganization. Under theconfirmed plan, the debtor can reduce itsdebts by repaying a portion of its obligationsand discharging others. The debtor can alsoterminate burdensome contracts and leases,recover assets, and rescale its operations inorder to return to profitability. Under chapter11, the debtor normally goes through a periodof consolidation and emerges with a reduceddebt load and a reorganized business.

Chapter 12, entitled Adjustment of Debts of aFamily Farmer or Fisherman with RegularAnnual Income, provides debt relief to familyfarmers and fishermen with regular income.The process under chapter 12 is very similarto that of chapter 13, under which the debtorproposes a plan to repay debts over a periodof time – no more than three years unless thecourt approves a longer period, not exceedingfive years. There is also a trustee in everychapter 12 case whose duties are very similarto those of a chapter 13 trustee. The chapter12 trustee’s disbursement of payments tocreditors under a confirmed plan parallels theprocedure under chapter 13. Chapter 12allows a family farmer or fisherman tocontinue to operate the business while theplan is being carried out.

Chapter 9, entitled Adjustment of Debts of aMunicipality, provides essentially forreorganization, much like a reorganizationunder chapter 11. Only a “municipality” mayfile under chapter 9, which includes cities and

8towns, as well as villages, counties, taxingdistricts, municipal utilities, and schooldistricts.

The purpose of Chapter 15, entitled Ancillaryand Other Cross-Border Cases, is to providean effective mechanism for dealing with casesof cross-border insolvency. This publicationdiscusses the applicability of Chapter 15where a debtor or its property is subject to thelaws of the United States and one or moreforeign countries.

In addition to the basic types of bankruptcycases, Bankruptcy Basics provides anoverview of the Servicemembers’ Civil ReliefAct, which, among other things, providesprotection to members of the military againstthe entry of default judgments and gives thecourt the ability to stay proceedings againstmilitary debtors.

This publication also contains a description ofliquidation proceedings under the SecuritiesInvestor Protection Act (“SIPA”). Althoughthe Bankruptcy Code provides for astockbroker liquidation proceeding, it is farmore likely that a failing brokerage firm willfind itself involved in a SIPA proceeding. Thepurpose of SIPA is to return to investorssecurities and cash left with failed brokerages.Since being established by Congress in 1970,the Securities Investor Protection Corporationhas protected investors who deposit stocksand bonds with brokerage firms by ensuringthat every customer’s property is protected, upto $500,000 per customer.

The bankruptcy process is complex and relieson legal concepts like the “automatic stay,”“discharge,” “exemptions,” and “assume.”Therefore, the final chapter of this publication is a glossary of Bankruptcy Terminology

which explains, in layman’s terms, most of thelegal concepts that apply in cases filed underthe Bankruptcy Code.

9

The Discharge inBankruptcy

The bankruptcy discharge varies dependingon the type of case a debtor files: chapter 7,11, 12, or 13. Bankruptcy Basics attempts toanswer some basic questions about thedischarge available to individual debtorsunder all four chapters including:

1. What is a discharge in bankruptcy?

2. When does the discharge occur?

3. How does the debtor get a discharge?

4. Are all the debtor’s debts discharged oronly some?

5. Does the debtor have a right to a dischargeor can creditors object to the discharge?

6. Can the debtor receive a second dischargein a later case?

7. Can the discharge be revoked?

8. May the debtor pay a discharged debt afterthe bankruptcy case has been concluded?

9. What can the debtor do if a creditorattempts to collect a discharged debt after thecase is concluded?

10. May an employer terminate a debtor’semployment solely because the person was adebtor or failed to repay a discharged debt?

WHAT IS A DISCHARGE IN BANKRUPTCY?

A bankruptcy discharge releases the debtorfrom personal liability for certain specifiedtypes of debts. In other words, the debtor is nolonger legally required to pay any debts thatare discharged. The discharge is a permanentorder prohibiting the creditors of the debtorfrom taking any form of collection action ondischarged debts, including legal action andcommunications with the debtor, such astelephone calls, letters, and personal contacts. Although a debtor is not personally liable fordischarged debts, a valid lien (i.e., a chargeupon specific property to secure payment of adebt) that has not been avoided (i.e., madeunenforceable) in the bankruptcy case willremain after the bankruptcy case. Therefore,a secured creditor may enforce the lien torecover the property secured by the lien.

WHEN DOES THE DISCHARGEOCCUR?

The timing of the discharge varies, dependingon the chapter under which the case is filed. Ina chapter 7 (liquidation) case, for example, thecourt usually grants the discharge promptly onexpiration of the time fixed for filing acomplaint objecting to discharge and the timefixed for filing a motion to dismiss the casefor substantial abuse (60 days following thefirst date set for the 341 meeting). Typically,this occurs about four months after the datethe debtor files the petition with the clerk ofthe bankruptcy court. In individual chapter 11cases, and in cases under chapter 12(adjustment of debts of a family farmer orfisherman) and 13 (adjustment of debts of anindividual with regular income), the courtgenerally grants the discharge as soon as

10practicable after the debtor completes allpayments under the plan. Since a chapter 12or chapter 13 plan may provide for paymentsto be made over three to five years, thedischarge typically occurs about four yearsafter the date of filing. The court may deny anindividual debtor’s discharge in a chapter 7 or13 case if the debtor fails to complete “aninstructional course concerning financialmanagement.” The Bankruptcy Code provideslimited exceptions to the “financialmanagement” requirement if the U.S. trusteeor bankruptcy administrator determines thereare inadequate educational programsavailable, or if the debtor is disabled orincapacitated or on active military duty in acombat zone.

HOW DOES THE DEBTOR GET ADISCHARGE?

Unless there is litigation involving objectionsto the discharge, the debtor will usuallyautomatically receive a discharge. The FederalRules of Bankruptcy Procedure provide forthe clerk of the bankruptcy court to mail acopy of the order of discharge to all creditors,the U.S. trustee, the trustee in the case, andthe trustee’s attorney, if any. The debtor andthe debtor’s attorney also receive copies of thedischarge order. The notice, which is simplya copy of the final order of discharge, is notspecific as to those debts determined by thecourt to be non-dischargeable, i.e., notcovered by the discharge. The notice informscreditors generally that the debts owed tothem have been discharged and that theyshould not attempt any further collection.They are cautioned in the notice thatcontinuing collection efforts could subjectthem to punishment for contempt. Anyinadvertent failure on the part of the clerk tosend the debtor or any creditor a copy of the

discharge order promptly within the timerequired by the rules does not affect thevalidity of the order granting the discharge.

ARE ALL OF THE DEBTOR’S DEBTSDISCHARGED OR ONLY SOME?

Not all debts are discharged. The debtsdischarged vary under each chapter of theBankruptcy Code. Section 523(a) of the Codespecifically excepts various categories ofdebts from the discharge granted to individualdebtors. Therefore, the debtor must still repaythose debts after bankruptcy. Congress hasdetermined that these types of debts are notdischargeable for public policy reasons (basedeither on the nature of the debt or the fact thatthe debts were incurred due to improperbehavior of the debtor, such as the debtor’sdrunken driving).

There are 19 categories of debt excepted fromdischarge under chapters 7, 11, and 12. Amore limited list of exceptions applies tocases under chapter 13.

Generally speaking, the exceptions todischarge apply automatically if the languageprescribed by section 523(a) applies. Themost common types of nondischargeabledebts are certain types of tax claims, debts notset forth by the debtor on the lists andschedules the debtor must file with the court,debts for spousal or child support or alimony,debts for willful and malicious injuries toperson or property, debts to governmentalunits for fines and penalties, debts for mostgovernment funded or guaranteed educationalloans or benefit overpayments, debts forpersonal injury caused by the debtor’soperation of a motor vehicle whileintoxicated, debts owed to certain tax-advantaged retirement plans, and debts for

11certain condominium or cooperative housingfees.

The types of debts described in sections523(a)(2), (4) and(6) (obligations affected byfraud or maliciousness) are not automaticallyexcepted from discharge. Creditors must askthe court to determine that these debts areexcepted from discharge. In the absence of anaffirmative request by the creditor and thegranting of the request by the court, the typesof debts set out in sections 523(a)(2), (4) and(6) will be discharged.

A slightly broader discharge of debts isavailable to a debtor in a chapter 13 case thanin a chapter 7 case. Debts dischargeable in achapter 13, but not in chapter 7, include debtsfor willful and malicious injury to property,debts incurred to pay non-dischargeable taxobligations, and debts arising from propertysettlements in divorce or separationproceedings. Although a chapter 13 debtorgenerally receives a discharge only aftercompleting all payments required by thecourt-approved (i.e., “confirmed”) repaymentplan, there are some limited circumstancesunder which the debtor may request the courtto grant a “hardship discharge” even thoughthe debtor has failed to complete planpayments. Such a discharge is available onlyto a debtor whose failure to complete planpayments is due to circumstances beyond thedebtor’s control. The scope of a chapter 13“hardship discharge” is similar to that in achapter 7 case with regard to the types ofdebts that are excepted from the discharge. Ahardship discharge also is available in chapter12 if the failure to complete plan payments isdue to “circumstances for which the debtorshould not justly be held accountable.”

DOES THE DEBTOR HAVE THE RIGHTTO A DISCHARGE OR CANCREDITORS OBJECT TO THEDISCHARGE?

In chapter 7 cases, the debtor does not have anabsolute right to a discharge. An objection tothe debtor’s discharge may be filed by acreditor, by the trustee in the case, or by theU.S. trustee. Creditors receive a notice shortlyafter the case is filed that sets forth muchimportant information, including the deadlinefor objecting to the discharge. To object to thedebtor’s discharge, a creditor must file acomplaint in the bankruptcy court before thedeadline set out in the notice. Filing acomplaint starts a lawsuit referred to inbankruptcy as an “adversary proceeding.”

The court may deny a chapter 7 discharge forany of the reasons described in section 727(a)of the Bankruptcy Code, including failure toprovide requested tax documents; failure tocomplete a course on personal financialmanagement; transfer or concealment ofproperty with intent to hinder, delay, ordefraud creditors; destruction or concealmentof books or records; perjury and otherfraudulent acts; failure to account for the lossof assets; violation of a court order or anearlier discharge in an earlier casecommenced within certain time frames(discussed below) before the date the petitionwas filed. If the issue of the debtor’s right toa discharge goes to trial, the objecting partyhas the burden of proving all the factsessential to the objection.

In chapter 12 and chapter 13 cases, the debtoris usually entitled to a discharge uponcompletion of all payments under the plan. As

12in chapter 7, however, discharge may notoccur in chapter 13 if the debtor fails tocomplete a required course on personalfinancial management. A debtor is alsoineligible for a discharge in chapter 13 if he orshe received a prior discharge in another casecommenced within time frames discussed thenext paragraph. Unlike chapter 7, creditors donot have standing to object to the discharge ofa chapter 12 or chapter 13 debtor. Creditorscan object to confirmation of the repaymentplan, but cannot object to the discharge if thedebtor has completed making plan payments.

CAN A DEBTOR RECEIVE A SECONDDISCHARGE IN A LATER CHAPTER 7CASE?

The court will deny a discharge in a laterchapter 7 case if the debtor received adischarge under chapter 7 or chapter 11 in acase filed within eight years before the secondpetition is filed. The court will also deny achapter 7 discharge if the debtor previouslyreceived a discharge in a chapter 12 or chapter13 case filed within six years before the dateof the filing of the second case unless (1) thedebtor paid all “allowed unsecured” claims inthe earlier case in full, or (2) the debtor madepayments under the plan in the earlier casetotaling at least 70 percent of the allowedunsecured claims and the debtor’s plan wasproposed in good faith and the paymentsrepresented the debtor’s best effort. A debtoris ineligible for discharge under chapter 13 ifhe or she received a prior discharge in achapter 7, 11, or 12 case filed four yearsbefore the current case or in a chapter 13 casefiled two years before the current case.

CAN THE DISCHARGE BE REVOKED?

The court may revoke a discharge undercertain circumstances. For example, a trustee,creditor, or the U.S. trustee may request thatthe court revoke the debtor’s discharge in achapter 7 case based on allegations that thedebtor: obtained the discharge fraudulently;failed to disclose the fact that he or sheacquired or became entitled to acquireproperty that would constitute property of thebankruptcy estate; committed one of severalacts of impropriety described in section727(a)(6) of the Bankruptcy Code; or failed toexplain any misstatements discovered in anaudit of the case or fails to provide documentsor information requested in an audit of thecase. Typically, a request to revoke thedebtor’s discharge must be filed within oneyear of the discharge or, in some cases, beforethe date that the case is closed. The court willdecide whether such allegations are true and,if so, whether to revoke the discharge.

In a chapter 11, 12 and 13 cases, ifconfirmation of a plan or the discharge isobtained through fraud, the court can revokethe order of confirmation or discharge.

MAY THE DEBTOR PAY ADISCHARGED DEBT AFTER THEBANKRUPTCY CASE HAS BEENCONCLUDED?

A debtor who has received a discharge mayvoluntarily repay any discharged debt. Adebtor may repay a discharged debt eventhough it can no longer be legally enforced.Sometimes a debtor agrees to repay a debtbecause it is owed to a family member orbecause it represents an obligation to anindividual for whom the debtor’s reputation isimportant, such as a family doctor.

13

WHAT CAN THE DEBTOR DO IF ACREDITOR ATTEMPTS TO COLLECTA DISCHARGED DEBT AFTER THECASE IS CONCLUDED?

If a creditor attempts collection efforts on adischarged debt, the debtor can file a motionwith the court, reporting the action and askingthat the case be reopened to address thematter. The bankruptcy court will often do soto ensure that the discharge is not violated.The discharge constitutes a permanentstatutory injunction prohibiting creditors fromtaking any action, including the filing of alawsuit, designed to collect a discharged debt.A creditor can be sanctioned by the court forviolating the discharge injunction. The normalsanction for violating the discharge injunctionis civil contempt, which is often punishable bya fine.

CAN AN EMPLOYER TERMINATE ADEBTOR’S EMPLOYMENT SOLELYBECAUSE THE PERSON WAS ADEBTOR OR FAILED TO PAY ADISCHARGED DEBT?

The law provides express prohibitions againstdiscriminatory treatment of debtors by bothgovernmental units and private employers. Agovernmental unit or private employer maynot discriminate against a person solelybecause the person was a debtor, wasinsolvent before or during the case, or has notpaid a debt that was discharged in the case.The law prohibits the following forms ofgovernmental discrimination: terminating anemployee; discriminating with respect tohiring; or denying, revoking, suspending, ordeclining to renew a license, franchise, or

similar privilege. A private employer may notdiscriminate with respect to employment if thediscrimination is based solely upon thebankruptcy filing.

14

Chapter 7

Liquidation Under the BankruptcyCode

ALTERNATIVES TO CHAPTER 7

Debtors should be aware that there are severalalternatives to chapter 7 relief. For example,debtors who are engaged in business,including corporations, partnerships, and soleproprietorships, may prefer to remain inbusiness and avoid liquidation. Such debtorsshould consider filing a petition under chapter11 of the Bankruptcy Code. Under chapter 11,the debtor may seek an adjustment of debts,either by reducing the debt or by extendingthe time for repayment, or may seek a morecomprehensive reorganization. Soleproprietorships may also be eligible for reliefunder chapter 13 of the Bankruptcy Code.

In addition, individual debtors who haveregular income may seek an adjustment ofdebts under chapter 13 of the BankruptcyCode. A particular advantage of chapter 13 isthat it provides individual debtors with anopportunity to save their homes fromforeclosure by allowing them to “catch up”past due payments through a payment plan.Moreover, the court may dismiss a chapter 7case filed by an individual whose debts areprimarily consumer rather than business debtsif the court finds that the granting of reliefwould be an abuse of chapter 7. 11 U.S.C. § 707(b).

If the debtor’s “current monthly income”1 ismore than the state median, the BankruptcyCode requires application of a “means test” todetermine whether the chapter 7 filing ispresumptively abusive. Abuse is presumed if

the debtor’s aggregate current monthlyincome over 5 years, net of certain statutorilyallowed expenses, is more than (i) $11,725, or(ii) 25% of the debtor’s nonpriority unsecureddebt, as long as that amount is at least$7,025.2 The debtor may rebut a presumptionof abuse only by a showing of specialcircumstances that justify additional expensesor adjustments of current monthly income.Unless the debtor overcomes the presumptionof abuse, the case will generally be convertedto chapter 13 (with the debtor’s consent) orwill be dismissed. 11 U.S.C. § 707(b)(1).

Debtors should also be aware that out-of-courtagreements with creditors or debt counselingservices may provide an alternative to abankruptcy filing.

BACKGROUND

A chapter 7 bankruptcy case does not involvethe filing of a plan of repayment as in chapter13. Instead, the bankruptcy trustee gathers andsells the debtor’s nonexempt assets and usesthe proceeds of such assets to pay holders ofclaims (creditors) in accordance with theprovisions of the Bankruptcy Code. Part of thedebtor’s property may be subject to liens andmortgages that pledge the property to othercreditors. In addition, the Bankruptcy Codewill allow the debtor to keep certain “exempt”property; but a trustee will liquidate thedebtor’s remaining assets. Accordingly,potential debtors should realize that the filingof a petition under chapter 7 may result in theloss of property.

CHAPTER 7 ELIGIBILITY

To qualify for relief under chapter 7 of theBankruptcy Code, the debtor may be an

15individual, a partnership, or a corporation orother business entity. 11 U.S.C. §§ 101(41), 109(b). Subject to the means testdescribed above for individual debtors, reliefis available under chapter 7 irrespective of theamount of the debtor’s debts or whether thedebtor is solvent or insolvent. An individualcannot file under chapter 7 or any otherchapter, however, if during the preceding 180days a prior bankruptcy petition wasdismissed due to the debtor’s willful failure toappear before the court or comply with ordersof the court, or the debtor voluntarilydismissed the previous case after creditorssought relief from the bankruptcy court torecover property upon which they hold liens.11 U.S.C. §§ 109(g), 362(d) and (e). Inaddition, no individual may be a debtor underchapter 7 or any chapter of the BankruptcyCode unless he or she has, within 180 daysbefore filing, received credit counseling froman approved credit counseling agency either inan individual or group briefing. 11 U.S.C. §§109, 111. There are exceptions in emergencysituations or where the U.S. trustee (orbankruptcy administrator) has determined thatthere are insufficient approved agencies toprovide the required counseling. If a debtmanagement plan is developed duringrequired credit counseling, it must be filedwith the court.

One of the primary purposes of bankruptcy isto discharge certain debts to give an honestindividual debtor a “fresh start.” The debtorhas no liability for discharged debts. In achapter 7 case, however, a discharge is onlyavailable to individual debtors, not topartnerships or corporations. 11 U.S.C.§ 727(a)(1). Although an individual chapter 7case usually results in a discharge of debts,the right to a discharge is not absolute, andsome types of debts are not discharged.

Moreover, a bankruptcy discharge does notextinguish a lien on property.

HOW CHAPTER 7 WORKS

A chapter 7 case begins with the debtor filinga petition with the bankruptcy court servingthe area where the individual lives or wherethe business debtor is organized or has itsprincipal place of business or principal assets.3

In addition to the petition, the debtor mustalso file with the court: (1) schedules of assetsand liabilities; (2) a schedule of currentincome and expenditures; (3) a statement offinancial affairs; and (4) a schedule ofexecutory contracts and unexpired leases. Fed.R. Bankr. P. 1007(b). Debtors must alsoprovide the assigned case trustee with a copyof the tax return or transcripts for the mostrecent tax year as well as tax returns filedduring the case (including tax returns for prioryears that had not been filed when the casebegan). 11 U.S.C. § 521. Individual debtorswith primarily consumer debts have additionaldocument filing requirements. They must file:a certificate of credit counseling and a copy ofany debt repayment plan developed throughcredit counseling; evidence of payment fromemployers, if any, received 60 days beforefiling; a statement of monthly net income andany anticipated increase in income orexpenses after filing; and a record of anyinterest the debtor has in federal or statequalified education or tuition accounts. Id. Ahusband and wife may file a joint petition orindividual petitions. 11 U.S.C. § 302(a). Evenif filing jointly, a husband and wife aresubject to all the document filing requirementsof individual debtors. (The Official Formsmay be purchased at legal stationery stores ordownloaded from the internet athttp://www.uscourts.gov/bkforms/index.html.They are not available from the court.)

16The courts must charge a $245 case filing fee,a $46 miscellaneous administrative fee, and a$15 trustee surcharge. Normally, the fees mustbe paid to the clerk of the court upon filing.With the court’s permission, however,individual debtors may pay in installments. 28U.S.C. § 1930(a); Fed. R. Bankr. P. 1006(b);Bankruptcy Court Miscellaneous FeeSchedule, Item 8. The number of installmentsis limited to four, and the debtor must makethe final installment no later than 120 daysafter filing the petition. Fed. R. Bankr. P.1006. For cause shown, the court may extendthe time of any installment, provided that thelast installment is paid not later than 180 daysafter filing the petition. Id. The debtor mayalso pay the $46 administrative fee and the$15 trustee surcharge in installments. If a jointpetition is filed, only one filing fee, oneadministrative fee, and one trustee surchargeare charged. Debtors should be aware thatfailure to pay these fees may result indismissal of the case. 11 U.S.C. § 707(a).

If the debtor’s income is less than 150% of thepoverty level (as defined in the BankruptcyCode), and the debtor is unable to pay thechapter 7 fees even in installments, the courtmay waive the requirement that the fees bepaid. 28 U.S.C. § 1930(f).

In order to complete the Official BankruptcyForms that make up the petition, statement offinancial affairs, and schedules, the debtormust provide the following information:

1. A list of all creditors and the amount andnature of their claims;

2. The source, amount, and frequency of thedebtor’s income;

3. A list of all of the debtor’s property; and

4. A detailed list of the debtor’s monthlyliving expenses, i.e., food, clothing, shelter,utilities, taxes, transportation, medicine, etc.

Married individuals must gather thisinformation for their spouse regardless ofwhether they are filing a joint petition,separate individual petitions, or even if onlyone spouse is filing. In a situation where onlyone spouse files, the income and expenses ofthe non-filing spouse is required so that thecourt, the trustee and creditors can evaluatethe household’s financial position.

Among the schedules that an individual debtorwill file is a schedule of “exempt” property.The Bankruptcy Code allows an individualdebtor4 to protect some property from theclaims of creditors because it is exempt underfederal bankruptcy law or under the laws ofthe debtor’s home state. 11 U.S.C. § 522(b).Many states have taken advantage of aprovision in the Bankruptcy Code that permitseach state to adopt its own exemption law inplace of the federal exemptions. In otherjurisdictions, the individual debtor has theoption of choosing between a federal packageof exemptions or the exemptions availableunder state law. Thus, whether certainproperty is exempt and may be kept by thedebtor is often a question of state law. Thedebtor should consult an attorney to determinethe exemptions available in the state wherethe debtor lives.

Filing a petition under chapter 7“automatically stays” (stops) most collectionactions against the debtor or the debtor’sproperty. 11 U.S.C. § 362. But filing thepetition does not stay certain types of actionslisted under 11 U.S.C. § 362(b), and the staymay be effective only for a short time in somesituations. The stay arises by operation of law

17and requires no judicial action. As long as thestay is in effect, creditors generally may notinitiate or continue lawsuits, wagegarnishments, or even telephone callsdemanding payments. The bankruptcy clerkgives notice of the bankruptcy case to allcreditors whose names and addresses areprovided by the debtor.

Between 21 and 40 days after the petition isfiled, the case trustee (described below) willhold a meeting of creditors. If the U.S. trusteeor bankruptcy administrator5 schedules themeeting at a place that does not have regularU.S. trustee or bankruptcy administratorstaffing, the meeting may be held no morethan 60 days after the order for relief. Fed. R.Bankr. P. 2003(a). During this meeting, thetrustee puts the debtor under oath, and boththe trustee and creditors may ask questions.The debtor must attend the meeting andanswer questions regarding the debtor’sfinancial affairs and property. 11 U.S.C. § 343. If a husband and wife have filed a jointpetition, they both must attend the creditors’meeting and answer questions. Within 14 daysof the creditors’ meeting, the U.S. trustee willreport to the court whether the case should bepresumed to be an abuse under the means testdescribed in 11 U.S.C. § 704(b).

It is important for the debtor to cooperate withthe trustee and to provide any financialrecords or documents that the trustee requests.The Bankruptcy Code requires the trustee toask the debtor questions at the meeting ofcreditors to ensure that the debtor is aware ofthe potential consequences of seeking adischarge in bankruptcy such as the effect oncredit history, the ability to file a petitionunder a different chapter, the effect ofreceiving a discharge, and the effect ofreaffirming a debt. Some trustees provide

written information on these topics at orbefore the meeting to ensure that the debtor isaware of this information. In order to preservetheir independent judgment, bankruptcyjudges are prohibited from attending themeeting of creditors. 11 U.S.C. § 341(c).

In order to accord the debtor complete relief,the Bankruptcy Code allows the debtor toconvert a chapter 7 case to case under chapter11, 12 or 136 as long as the debtor is eligibleto be a debtor under the new chapter.However, a condition of the debtor’svoluntary conversion is that the case has notpreviously been converted to chapter 7 fromanother chapter. 11 U.S.C. § 706(a). Thus, thedebtor will not be permitted to convert thecase repeatedly from one chapter to another.

ROLE OF THE CASE TRUSTEE

When a chapter 7 petition is filed, the U.S.trustee (or the bankruptcy court in Alabamaand North Carolina) appoints an impartialcase trustee to administer the case andliquidate the debtor’s nonexempt assets. 11U.S.C. §§ 701, 704. If all the debtor’s assetsare exempt or subject to valid liens, the trusteewill normally file a “no asset” report with thecourt, and there will be no distribution tounsecured creditors. Most chapter 7 casesinvolving individual debtors are no assetcases. But if the case appears to be an “asset”case at the outset, unsecured creditors7 mustfile their claims with the court within 90 daysafter the first date set for the meeting ofcreditors. Fed. R. Bankr. P. 3002(c). Agovernmental unit, however, has 180 daysfrom the date the case is filed to file a claim.11 U.S.C. § 502(b)(9). In the typical no assetchapter 7 case, there is no need for creditors tofile proofs of claim because there will be nodistribution. If the trustee later recovers assets

18for distribution to unsecured creditors, theBankruptcy Court will provide notice tocreditors and will allow additional time to fileproofs of claim. Although a secured creditordoes not need to file a proof of claim in achapter 7 case to preserve its security interestor lien, there may be other reasons to file aclaim. A creditor in a chapter 7 case who hasa lien on the debtor’s property should consultan attorney for advice.

Commencement of a bankruptcy case createsan “estate.” The estate technically becomesthe temporary legal owner of all the debtor’sproperty. It consists of all legal or equitableinterests of the debtor in property as of thecommencement of the case, includingproperty owned or held by another person ifthe debtor has an interest in the property.Generally speaking, the debtor’s creditors arepaid from nonexempt property of the estate.

The primary role of a chapter 7 trustee in anasset case is to liquidate the debtor’snonexempt assets in a manner that maximizesthe return to the debtor’s unsecured creditors.The trustee accomplishes this by selling thedebtor’s property if it is free and clear of liens(as long as the property is not exempt) or if itis worth more than any security interest or lienattached to the property and any exemptionthat the debtor holds in the property. Thetrustee may also attempt to recover money orproperty under the trustee’s “avoidingpowers.” The trustee’s avoiding powersinclude the power to: set aside preferentialtransfers made to creditors within 90 daysbefore the petition; undo security interests andother prepetition transfers of property thatwere not properly perfected undernonbankruptcy law at the time of the petition;and pursue nonbankruptcy claims such asfraudulent conveyance and bulk transfer

remedies available under state law. Inaddition, if the debtor is a business, thebankruptcy court may authorize the trustee tooperate the business for a limited period oftime, if such operation will benefit creditorsand enhance the liquidation of the estate. 11U.S.C. § 721.

Section 726 of the Bankruptcy Code governsthe distribution of the property of the estate.Under § 726, there are six classes of claims;and each class must be paid in full before thenext lower class is paid anything. The debtoris only paid if all other classes of claims havebeen paid in full. Accordingly, the debtor isnot particularly interested in the trustee’sdisposition of the estate assets, except withrespect to the payment of those debts whichfor some reason are not dischargeable in thebankruptcy case. The individual debtor’sprimary concerns in a chapter 7 case are toretain exempt property and to receive adischarge that covers as many debts aspossible.

THE CHAPTER 7 DISCHARGE

A discharge releases individual debtors frompersonal liability for most debts and preventsthe creditors owed those debts from takingany collection actions against the debtor.Because a chapter 7 discharge is subject tomany exceptions, though, debtors shouldconsult competent legal counsel before filingto discuss the scope of the discharge.Generally, excluding cases that are dismissedor converted, individual debtors receive adischarge in more than 99 percent of chapter7 cases. In most cases, unless a party ininterest files a complaint objecting to thedischarge or a motion to extend the time toobject, the bankruptcy court will issue adischarge order relatively early in the case –

19generally, 60 to 90 days after the date first setfor the meeting of creditors. Fed. R. Bankr. P.4004(c).

The grounds for denying an individual debtora discharge in a chapter 7 case are narrow andare construed against the moving party.Among other reasons, the court may deny thedebtor a discharge if it finds that the debtor:failed to keep or produce adequate books orfinancial records; failed to explainsatisfactorily any loss of assets; committed abankruptcy crime such as perjury; failed toobey a lawful order of the bankruptcy court;fraudulently transferred, concealed, ordestroyed property that would have becomeproperty of the estate; or failed to complete anapproved instructional course concerningfinancial management. 11 U.S.C. § 727; Fed.R. Bankr. P. 4005.

Secured creditors may retain some rights toseize property securing an underlying debteven after a discharge is granted. Dependingon individual circumstances, if a debtorwishes to keep certain secured property (suchas an automobile), he or she may decide to“reaffirm” the debt. A reaffirmation is anagreement between the debtor and the creditorthat the debtor will remain liable and will payall or a portion of the money owed, eventhough the debt would otherwise bedischarged in the bankruptcy. In return, thecreditor promises that it will not repossess ortake back the automobile or other property solong as the debtor continues to pay the debt.

If the debtor decides to reaffirm a debt, he orshe must do so before the discharge is entered.The debtor must sign a written reaffirmationagreement and file it with the court. 11 U.S.C.§ 524(c). The Bankruptcy Code requires thatreaffirmation agreements contain an extensive

set of disclosures described in 11 U.S.C. §524(k). Among other things, the disclosuresmust advise the debtor of the amount of thedebt being reaffirmed and how it is calculatedand that reaffirmation means that the debtor’spersonal liability for that debt will not bedischarged in the bankruptcy. The disclosuresalso require the debtor to sign and file astatement of his or her current income andexpenses which shows that the balance ofincome paying expenses is sufficient to paythe reaffirmed debt. If the balance is notenough to pay the debt to be reaffirmed, thereis a presumption of undue hardship, and thecourt may decide not to approve thereaffirmation agreement. Unless the debtor isrepresented by an attorney, the bankruptcyjudge must approve the reaffirmationagreement.

If the debtor was represented by an attorney inconnection with the reaffirmation agreement,the attorney must certify in writing that he orshe advised the debtor of the legal effect andconsequences of the agreement, including adefault under the agreement. The attorneymust also certify that the debtor was fullyinformed and voluntarily made the agreementand that reaffirmation of the debt will notcreate an undue hardship for the debtor or thedebtor’s dependants. 11 U.S.C. § 524(k). TheBankruptcy Code requires a reaffirmationhearing if the debtor has not been representedby an attorney during the negotiating of theagreement, or if the court disapproves thereaffirmation agreement.11 U.S.C. § 524(d)and (m). The debtor may repay any debtvoluntarily, however, whether or not areaffirmation agreement exists. 11 U.S.C. § 524(f).

An individual receives a discharge for most ofhis or her debts in a chapter 7 bankruptcy

20case. A creditor may no longer initiate orcontinue any legal or other action against thedebtor to collect a discharged debt. But not allof an individual’s debts are discharged inchapter 7. Debts not discharged include debtsfor alimony and child support, certain taxes,debts for certain educational benefitoverpayments or loans made or guaranteed bya governmental unit, debts for willful andmalicious injury by the debtor to anotherentity or to the property of another entity,debts for death or personal injury caused bythe debtor’s operation of a motor vehiclewhile the debtor was intoxicated from alcoholor other substances, and debts for certaincriminal restitution orders.11 U.S.C. § 523(a).The debtor will continue to be liable for thesetypes of debts to the extent that they are notpaid in the chapter 7 case. Debts for money orproperty obtained by false pretenses, debts forfraud or defalcation while acting in a fiduciarycapacity, and debts for willful and maliciousinjury by the debtor to another entity or to theproperty of another entity will be dischargedunless a creditor timely files and prevails in anaction to have such debts declarednondischargeable. 11 U.S.C. § 523(c); Fed. R.Bankr. P. 4007(c).

The court may revoke a chapter 7 dischargeon the request of the trustee, a creditor, or theU.S. trustee if the discharge was obtainedthrough fraud by the debtor, if the debtoracquired property that is property of the estateand knowingly and fraudulently failed toreport the acquisition of such property or tosurrender the property to the trustee, or if thedebtor (without a satisfactory explanation)makes a material misstatement or fails toprovide documents or other information inconnection with an audit of the debtor’s case.11 U.S.C. § 727(d).

NOTES

1. The “current monthly income” received bythe debtor is a defined term in the BankruptcyCode and means the average monthly incomereceived over the six calendar months beforecommencement of the bankruptcy case,including regular contributions to householdexpenses from nondebtors and includingincome from the debtor’s spouse if thepetition is a joint petition, but not includingsocial security income or certain paymentsmade because the debtor is the victim ofcertain crimes. 11 U.S.C. § 101(10A).

2. To determine whether a presumption ofabuse arises, all individual debtors withprimarily consumer debts who file a chapter 7case must complete Official Bankruptcy FormB22A, entitled “Statement of Current MonthlyIncome and Means Test Calculation - For Usein Chapter 7.” (The Official Forms may bepurchased at legal stationery stores ordownloaded from the internet at: http://www.uscourts.gov/bkforms/index.html.They are not available from the court.)

3. An involuntary chapter 7 case may becommenced under certain circumstances by apetition filed by creditors holding claimsagainst the debtor. 11 U.S.C. § 303.

4. Each debtor in a joint case (both husbandand wife) can claim exemptions under thefederal bankruptcy laws. 11 U.S.C. § 522(m).

5. In North Carolina and Alabama, bankruptcyadministrators perform similar functions thatU.S. trustees perform in the remaining 48states. These duties include establishing apanel of private trustees to serve as trustees inchapter 7 cases and supervising theadministration of cases and trustees in cases

21under chapters 7, 11, 12, and 13 of theBankruptcy Code. The bankruptcyadministrator program is administered by theAdministrative Office of the United StatesCourts, while the U.S. trustee program isadministered by the Department of Justice.For purposes of this publication, references toU.S. trustees are also applicable to bankruptcyadministrators.

6. A fee is charged for converting, on requestof the debtor, a case under chapter 7 to a caseunder chapter 11. The fee charged is thedifference between the filing fee for a chapter7 and the filing fee for a chapter 11. 28 U.S.C.§ 1930(a). Currently, the difference is $755.Id. There is no fee for converting from chapter7 to chapter 13.

7. Unsecured debts generally may be definedas those for which the extension of credit wasbased purely upon an evaluation by thecreditor of the debtor’s ability to pay, asopposed to secured debts, for which theextension of credit was based upon thecreditor’s right to seize collateral on default,in addition to the debtor’s ability to pay.

22

Chapter 13

Individual Debt Adjustment

BACKGROUND

A chapter 13 bankruptcy is also called a wageearner’s plan. It enables individuals withregular income to develop a plan to repay allor part of their debts. Under this chapter,debtors propose a repayment plan to makeinstallments to creditors over three to fiveyears. If the debtor’s current monthly incomeis less than the applicable state median, theplan will be for three years unless the courtapproves a longer period “for cause.”1 If thedebtor’s current monthly income is greaterthan the applicable state median, the plangenerally must be for five years. In no casemay a plan provide for payments over aperiod longer than five years. 11 U.S.C.§1322(d). During this time the law forbidscreditors from starting or continuingcollection efforts.

This chapter discusses six aspects of a chapter13 proceeding: the advantages of choosingchapter 13, the chapter 13 eligibilityrequirements, how a chapter 13 proceedingworks, what may be included in chapter 13repayment plan and how it is confirmed,making the plan work, and the special chapter13 discharge.

ADVANTAGES OF CHAPTER 13

Chapter 13 offers individuals a number ofadvantages over liquidation under chapter 7.Perhaps most significantly, chapter 13 offersindividuals an opportunity to save their homesfrom foreclosure. By filing under this chapter,individuals can stop foreclosure proceedings

and may cure delinquent mortgage paymentsover time. Nevertheless, they must still makeall mortgage payments that come due duringthe chapter 13 plan on time. Anotheradvantage of chapter 13 is that it allowsindividuals to reschedule secured debts (otherthan a mortgage for their primary residence)and extend them over the life of the chapter13 plan. Doing this may lower the payments.Chapter 13 also has a special provision thatprotects third parties who are liable with thedebtor on “consumer debts.” This provisionmay protect co-signers. Finally, chapter 13acts like a consolidation loan under which theindividual makes the plan payments to achapter 13 trustee who then distributespayments to creditors. Individuals will haveno direct contact with creditors while underchapter 13 protection.

CHAPTER 13 ELIGIBILITY

Any individual, even if self-employed oroperating an unincorporated business, iseligible for chapter 13 relief as long as theindividual’s unsecured debts are less than$360,475 and secured debts are less than$1,081,400. 11 U.S.C. § 109(e). Theseamounts are adjusted periodically to reflectchanges in the consumer price index. Acorporation or partnership may not be achapter 13 debtor. Id.

An individual cannot file under chapter 13 orany other chapter if, during the preceding 180days, a prior bankruptcy petition wasdismissed due to the debtor’s willful failure toappear before the court or comply with ordersof the court or was voluntarily dismissed aftercreditors sought relief from the bankruptcycourt to recover property upon which theyhold liens. 11 U.S.C. §§ 109(g), 362(d) and(e). In addition, no individual may be a debtor

23under chapter 13 or any chapter of theBankruptcy Code unless he or she has, within180 days before filing, received creditcounseling from an approved creditcounseling agency either in an individual orgroup briefing. 11 U.S.C. §§ 109, 111. Thereare exceptions in emergency situations orwhere the U.S. trustee (or bankruptcyadministrator) has determined that there areinsufficient approved agencies to provide therequired counseling. If a debt managementplan is developed during required creditcounseling, it must be filed with the court.

HOW CHAPTER 13 WORKS

A chapter 13 case begins by filing a petitionwith the bankruptcy court serving the areawhere the debtor has a domicile or residence.Unless the court orders otherwise, the debtormust also file with the court: (1) schedules ofassets and liabilities; (2) a schedule of currentincome and expenditures; (3) a schedule ofexecutory contracts and unexpired leases; and(4) a statement of financial affairs. Fed. R.Bankr. P. 1007(b). The debtor must also file acertificate of credit counseling and a copy ofany debt repayment plan developed throughcredit counseling; evidence of payment fromemployers, if any, received 60 days beforefiling; a statement of monthly net income andany anticipated increase in income orexpenses after filing; and a record of anyinterest the debtor has in federal or statequalified education or tuition accounts. 11U.S.C. § 521. The debtor must provide thechapter 13 case trustee with a copy of the taxreturn or transcripts for the most recent taxyear as well as tax returns filed during thecase (including tax returns for prior years thathad not been filed when the case began). Id. Ahusband and wife may file a joint petition orindividual petitions. 11 U.S.C. § 302(a). (The

Official Forms may be purchased at legalstationery stores or downloaded from theinternet at http://www.uscourts.gov/bkforms/index.html.They are not available from the court.)

The courts must charge a $235 case filing feeand a $46 miscellaneous administrative fee.Normally the fees must be paid to the clerk ofthe court upon filing. With the court’spermission, however, they may be paid ininstallments. 28 U.S.C. § 1930(a); Fed. R.Bankr. P. 1006(b); Bankruptcy CourtMiscellaneous Fee Schedule, Item 8. Thenumber of installments is limited to four, andthe debtor must make the final installment nolater than 120 days after filing the petition.Fed. R. Bankr. P. 1006(b). For cause shown,the court may extend the time of anyinstallment, as long as the last installment ispaid no later than 180 days after filing thepetition. Id. The debtor may also pay the $46administrative fee in installments. If a jointpetition is filed, only one filing fee and oneadministrative fee are charged. Debtors shouldbe aware that failure to pay these fees mayresult in dismissal of the case. 11 U.S.C. §1307(c)(2).

In order to complete the Official BankruptcyForms that make up the petition, statement offinancial affairs, and schedules, the debtormust compile the following information:

1. A list of all creditors and the amounts andnature of their claims;

2. The source, amount, and frequency of thedebtor’s income;

3. A list of all of the debtor’s property; and

244. A detailed list of the debtor’s monthlyliving expenses, i.e., food, clothing, shelter,utilities, taxes, transportation, medicine, etc. Married individuals must gather thisinformation for their spouse regardless ofwhether they are filing a joint petition,separate individual petitions, or even if onlyone spouse is filing. In a situation where onlyone spouse files, the income and expenses ofthe non-filing spouse is required so that thecourt, the trustee and creditors can evaluatethe household’s financial position.

When an individual files a chapter 13 petition,an impartial trustee is appointed to administerthe case. 11 U.S.C. § 1302. In some districts,the U.S. trustee or bankruptcy administrator2

appoints a standing trustee to serve in allchapter 13 cases. 28 U.S.C. § 586(b). Thechapter 13 trustee both evaluates the case andserves as a disbursing agent, collectingpayments from the debtor and makingdistributions to creditors. 11 U.S.C. § 1302(b).

Filing the petition under chapter 13“automatically stays” (stops) most collectionactions against the debtor or the debtor’sproperty. 11 U.S.C. § 362. Filing the petitiondoes not, however, stay certain types ofactions listed under 11 U.S.C. § 362(b), andthe stay may be effective only for a short timein some situations. The stay arises byoperation of law and requires no judicialaction. As long as the stay is in effect,creditors generally may not initiate orcontinue lawsuits, wage garnishments, or evenmake telephone calls demanding payments.The bankruptcy clerk gives notice of thebankruptcy case to all creditors whose namesand addresses are provided by the debtor.

Chapter 13 also contains a special automaticstay provision that protects co-debtors. Unless

the bankruptcy court authorizes otherwise, acreditor may not seek to collect a “consumerdebt” from any individual who is liable alongwith the debtor. 11 U.S.C. § 1301(a).Consumer debts are those incurred by anindividual primarily for a personal, family, orhousehold purpose. 11 U.S.C. § 101(8).

Individuals may use a chapter 13 proceedingto save their home from foreclosure. Theautomatic stay stops the foreclosureproceeding as soon as the individual files thechapter 13 petition. The individual may thenbring the past-due payments current over areasonable period of time. Nevertheless, thedebtor may still lose the home if the mortgagecompany completes the foreclosure sale understate law before the debtor files the petition.11U.S.C. § 1322(c). The debtor may also losethe home if he or she fails to make the regularmortgage payments that come due after thechapter 13 filing.

Between 21 and 50 days after the debtor filesthe chapter 13 petition, the chapter 13 trusteewill hold a meeting of creditors. If the U.S.trustee or bankruptcy administrator schedulesthe meeting at a place that does not haveregular U.S. trustee or bankruptcyadministrator staffing, the meeting may beheld no more than 60 days after the debtorfiles. Fed. R. Bankr. P. 2003(a). During thismeeting, the trustee places the debtor underoath, and both the trustee and creditors mayask questions. The debtor must attend themeeting and answer questions regarding his orher financial affairs and the proposed terms ofthe plan.11 U.S.C. § 343. If a husband andwife file a joint petition, they both must attendthe creditors’ meeting and answer questions.In order to preserve their independentjudgment, bankruptcy judges are prohibitedfrom attending the creditors’ meeting. 11

25U.S.C. § 341(c). The parties typically resolveproblems with the plan either during orshortly after the creditors’ meeting. Generally,the debtor can avoid problems by making surethat the petition and plan are complete andaccurate, and by consulting with the trusteeprior to the meeting.

In a chapter 13 case, to participate indistributions from the bankruptcy estate,unsecured creditors must file their claims withthe court within 90 days after the first date setfor the meeting of creditors. Fed. R. Bankr. P.3002(c). A governmental unit, however, has180 days from the date the case is filed file aproof of claim.11 U.S.C. § 502(b)(9).

After the meeting of creditors, the debtor, thechapter 13 trustee, and those creditors whowish to attend will come to court for a hearingon the debtor’s chapter 13 repayment plan.

THE CHAPTER 13 PLAN ANDCONFIRMATION HEARING

Unless the court grants an extension, thedebtor must file a repayment plan with thepetition or within 14 days after the petition isfiled. Fed. R. Bankr. P. 3015. A plan must besubmitted for court approval and must providefor payments of fixed amounts to the trusteeon a regular basis, typically biweekly ormonthly. The trustee then distributes the fundsto creditors according to the terms of the plan,which may offer creditors less than fullpayment on their claims.

There are three types of claims: priority,secured, and unsecured. Priority claims arethose granted special status by the bankruptcylaw, such as most taxes and the costs ofbankruptcy proceeding.3 Secured claims arethose for which the creditor has the right takeback certain property (i.e., the collateral) if

the debtor does not pay the underlying debt.In contrast to secured claims, unsecuredclaims are generally those for which thecreditor has no special rights to collect againstparticular property owned by the debtor.

The plan must pay priority claims in fullunless a particular priority creditor agrees todifferent treatment of the claim or, in the caseof a domestic support obligation, unless thedebtor contributes all “disposable income” -discussed below - to a five-year plan.11 U.S.C. § 1322(a).

If the debtor wants to keep the collateralsecuring a particular claim, the plan mustprovide that the holder of the secured claimreceive at least the value of the collateral. Ifthe obligation underlying the secured claimwas used to buy the collateral (e.g., a carloan), and the debt was incurred within certaintime frames before the bankruptcy filing, theplan must provide for full payment of thedebt, not just the value of the collateral (whichmay be less due to depreciation). Payments tocertain secured creditors (i.e., the homemortgage lender), may be made over theoriginal loan repayment schedule (which maybe longer than the plan) so long as anyarrearage is made up during the plan. Thedebtor should consult an attorney to determinethe proper treatment of secured claims in theplan.

The plan need not pay unsecured claims infull as long it provides that the debtor will payall projected “disposable income” over an“applicable commitment period,” and as longas unsecured creditors receive at least as muchunder the plan as they would receive if thedebtor’s assets were liquidated under chapter7. 11 U.S.C. § 1325. In chapter 13,“disposable income” is income (other thanchild support payments received by the

26debtor) less amounts reasonably necessary forthe maintenance or support of the debtor ordependents and less charitable contributionsup to 15% of the debtor’s gross income. If thedebtor operates a business, the definition ofdisposable income excludes those amountswhich are necessary for ordinary operatingexpenses. 11 U.S.C. § 1325(b)(2)(A) and (B).The “applicable commitment period” dependson the debtor’s current monthly income. Theapplicable commitment period must be threeyears if current monthly income is less thanthe state median for a family of the same size- and five years if the current monthly incomeis greater than a family of the same size. 11U.S.C. § 1325(d). The plan may be less thanthe applicable commitment period (three orfive years) only if unsecured debt is paid infull over a shorter period.

Within 30 days after filing the bankruptcycase, even if the plan has not yet beenapproved by the court, the debtor must startmaking plan payments to the trustee. 11U.S.C. § 1326(a)(1). If any secured loanpayments or lease payments come due beforethe debtor’s plan is confirmed (typically homeand automobile payments), the debtor mustmake adequate protection payments directlyto the secured lender or lessor - deducting theamount paid from the amount that wouldotherwise be paid to the trustee. Id.

No later than 45 days after the meeting ofcreditors, the bankruptcy judge must hold aconfirmation hearing and decide whether theplan is feasible and meets the standards forconfirmation set forth in the BankruptcyCode. 11 U.S.C. §§ 1324, 1325. Creditors willreceive 28 days’ notice of the hearing andmay object to confirmation. Fed. R. Bankr. P.2002(b). While a variety of objections may bemade, the most frequent ones are thatpayments offered under the plan are less than

creditors would receive if the debtor’s assetswere liquidated or that the debtor’s plan doesnot commit all of the debtor’s projecteddisposable income for the three or five yearapplicable commitment period.

If the court confirms the plan, the chapter 13trustee will distribute funds received under theplan “as soon as is practicable.” 11 U.S.C.§ 1326(a)(2). If the court declines to confirmthe plan, the debtor may file a modified plan.11 U.S.C. § 1323. The debtor may alsoconvert the case to a liquidation case underchapter 7.4 11 U.S.C. § 1307(a). If the courtdeclines to confirm the plan or the modifiedplan and instead dismisses the case, the courtmay authorize the trustee to keep some fundsfor costs, but the trustee must return allremaining funds to the debtor (other thanfunds already disbursed or due to creditors).11 U.S.C. § 1326(a)(2).

Occasionally, a change in circumstances maycompromise the debtor’s ability to make planpayments. For example, a creditor may objector threaten to object to a plan, or the debtormay inadvertently have failed to list allcreditors. In such instances, the plan may bemodified either before or after confirmation.11 U.S.C. §§ 1323, 1329. Modification afterconfirmation is not limited to an initiative bythe debtor, but may be at the request of thetrustee or an unsecured creditor. 11 U.S.C. § 1329(a).

MAKING THE PLAN WORK

The provisions of a confirmed plan bind thedebtor and each creditor. 11 U.S.C. § 1327.Once the court confirms the plan, the debtormust make the plan succeed. The debtor mustmake regular payments to the trustee eitherdirectly or through payroll deduction, whichwill require adjustment to living on a fixed

27budget for a prolonged period. Furthermore,while confirmation of the plan entitles thedebtor to retain property as long as paymentsare made, the debtor may not incur new debtwithout consulting the trustee, becauseadditional debt may compromise the debtor’sability to complete the plan. 11 U.S.C. §§ 1305(c), 1322(a)(1), 1327.

A debtor may make plan payments throughpayroll deductions. This practice increases thelikelihood that payments will be made on timeand that the debtor will complete the plan. Inany event, if the debtor fails to make thepayments due under the confirmed plan, thecourt may dismiss the case or convert it to aliquidation case under chapter 7 of theBankruptcy Code. 11 U.S.C. § 1307(c). Thecourt may also dismiss or convert the debtor’scase if the debtor fails to pay any post-filingdomestic support obligations (i.e., childsupport, alimony), or fails to make requiredtax filings during the case. 11 U.S.C. §§ 1307(c) and (e), 1308, 521.

THE CHAPTER 13 DISCHARGE

The bankruptcy law regarding the scope of thechapter 13 discharge is complex and hasrecently undergone major changes. Therefore,debtors should consult competent legalcounsel prior to filing regarding the scope ofthe chapter 13 discharge.

A chapter 13 debtor is entitled to a dischargeupon completion of all payments under thechapter 13 plan so long as the debtor: (1)certifies (if applicable) that all domesticsupport obligations that came due prior tomaking such certification have been paid; (2)has not received a discharge in a prior casefiled within a certain time frame (two yearsfor prior chapter 13 cases and four years forprior chapter 7, 11 and 12 cases); and (3) has

completed an approved course in financialmanagement (if the U.S. trustee or bankruptcyadministrator for the debtor’s district hasdetermined that such courses are available tothe debtor). 11 U.S.C. § 1328. The court willnot enter the discharge, however, until itdetermines, after notice and a hearing, thatthere is no reason to believe there is anypending proceeding that might give rise to alimitation on the debtor’s homesteadexemption. 11 U.S.C. § 1328(h).

The discharge releases the debtor from alldebts provided for by the plan or disallowed(under section 502), with limited exceptions.Creditors provided for in full or in part underthe chapter 13 plan may no longer initiate orcontinue any legal or other action against thedebtor to collect the discharged obligations.

As a general rule, the discharge releases thedebtor from all debts provided for by the planor disallowed, with the exception of certaindebts referenced in 11 U.S.C. § 1328. Debtsnot discharged in chapter 13 include certainlong term obligations (such as a homemortgage), debts for alimony or child support,certain taxes, debts for most governmentfunded or guaranteed educational loans orbenefit overpayments, debts arising fromdeath or personal injury caused by drivingwhile intoxicated or under the influence ofdrugs, and debts for restitution or a criminalfine included in a sentence on the debtor’sconviction of a crime. To the extent that theyare not fully paid under the chapter 13 plan,the debtor will still be responsible for thesedebts after the bankruptcy case has concluded.Debts for money or property obtained by falsepretenses, debts for fraud or defalcation whileacting in a fiduciary capacity, and debts forrestitution or damages awarded in a civil casefor willful or malicious actions by the debtorthat cause personal injury or death to a person

28will be discharged unless a creditor timelyfiles and prevails in an action to have suchdebts declared nondischargeable. 11 U.S.C. §§ 1328, 523(c); Fed. R. Bankr. P. 4007(c).

The discharge in a chapter 13 case issomewhat broader than in a chapter 7 case.Debts dischargeable in a chapter 13, but not inchapter 7, include debts for willful andmalicious injury to property (as opposed to aperson) , debts incurred to paynondischargeable tax obligations, and debtsarising from property settlements in divorce orseparation proceedings. 11 U.S.C. § 1328(a).

THE CHAPTER 13 HARDSHIPDISCHARGE

After confirmation of a plan, circumstancesmay arise that prevent the debtor fromcompleting the plan. In such situations, thedebtor may ask the court to grant a “hardshipdischarge.” 11 U.S.C. § 1328(b). Generally,such a discharge is available only if: (1) thedebtor’s failure to complete plan payments isdue to circumstances beyond the debtor’scontrol and through no fault of the debtor; (2)creditors have received at least as much asthey would have received in a chapter 7liquidation case; and (3) modification of theplan is not possible. Injury or illness thatprecludes employment sufficient to fund evena modified plan may serve as the basis for ahardship discharge. The hardship discharge ismore limited than the discharge describedabove and does not apply to any debts that arenondischargeable in a chapter 7 case. 11U.S.C. § 523.

NOTES

1. The “current monthly income” received bythe debtor is a defined term in the BankruptcyCode and means the average monthly income

received over the six calendar months beforecommencement of the bankruptcy case,including regular contributions to householdexpenses from nondebtors and includingincome from the debtor’s spouse if thepetition is a joint petition, but not includingsocial security income or certain paymentsmade because the debtor is the victim ofcertain crimes. 11 U.S.C. § 101(10A).

2. In North Carolina and Alabama, bankruptcyadministrators perform similar functions thatU.S. trustees perform in the remaining forty-eight states. The bankruptcy administratorprogram is administered by theAdministrative Office of the United StatesCourts, while the U.S. trustee program isadministered by the Department of Justice.For purposes of this publication, references toU.S. trustees are also applicable to bankruptcyadministrators.

3. Section 507 sets forth 10 categories ofunsecured claims which Congress has, forpublic policy reasons, given priority ofdistribution over other unsecured claims.

4. A fee of $15 is charged for converting acase under chapter 13 to a case under chapter7.

29

Chapter 11

Reorganization Under theBankruptcy Code

BACKGROUND

A case filed under chapter 11 of the UnitedStates Bankruptcy Code is frequently referredto as a “reorganization” bankruptcy.

An individual cannot file under chapter 11 orany other chapter if, during the preceding 180days, a prior bankruptcy petition wasdismissed due to the debtor’s willful failure toappear before the court or comply with ordersof the court, or was voluntarily dismissed aftercreditors sought relief from the bankruptcycourt to recover property upon which theyhold liens. 11 U.S.C. §§ 109(g), 362(d)-(e). Inaddition, no individual may be a debtor underchapter 11 or any chapter of the BankruptcyCode unless he or she has, within 180 daysbefore filing, received credit counseling froman approved credit counseling agency either inan individual or group briefing. 11 U.S.C. §§ 109, 111. There are exceptions inemergency situations or where the U.S. trustee(or bankruptcy administrator) has determinedthat there are insufficient approved agenciesto provide the required counseling. If a debtmanagement plan is developed duringrequired credit counseling, it must be filedwith the court.

HOW CHAPTER 11 WORKS

A chapter 11 case begins with the filing of apetition with the bankruptcy court serving thearea where the debtor has a domicile orresidence. A petition may be a voluntarypetition, which is filed by the debtor, or it maybe an involuntary petition, which is filed by

creditors that meet certain requirements. 11U.S.C. §§ 301, 303. A voluntary petition mustadhere to the format of Form 1 of the OfficialForms prescribed by the Judicial Conferenceof the United States. Unless the court ordersotherwise, the debtor also must file with thecourt: (1) schedules of assets and liabilities;(2) a schedule of current income andexpenditures; (3) a schedule of executorycontracts and unexpired leases; and (4) astatement of financial affairs. Fed. R. Bankr.P. 1007(b). If the debtor is an individual (orhusband and wife), there are additionaldocument filing requirements. Such debtorsmust file: a certificate of credit counseling anda copy of any debt repayment plan developedthrough credit counseling; evidence ofpayment from employers, if any, received 60days before filing; a statement of monthly netincome and any anticipated increase inincome or expenses after filing; and a recordof any interest the debtor has in federal orstate qualified education or tuitionaccounts.11 U.S.C. § 521. A husband andwife may file a joint petition or individualpetitions. 11 U.S.C. § 302(a). (The OfficialForms are not available from the court, butmay be purchased at legal stationery stores ordownloaded from the internet at:http://www.uscourts.gov/bkforms/index.html.)

The courts are required to charge an $1,000case filing fee and a $46 miscellaneousadministrative fee. The fees must be paid tothe clerk of the court upon filing or may, withthe court’s permission, be paid by individualdebtors in installments. 28 U.S.C. § 1930(a);Fed. R. Bankr. P. 1006(b); Bankruptcy CourtMiscellaneous Fee Schedule, Item 8. Fed. R.Bankr. P. 1006(b) limits to four the number ofinstallments for the filing fee. The finalinstallment must be paid not later than 120days after filing the petition. For cause shown,the court may extend the time of any

30installment, provided that the last installmentis paid not later than 180 days after the filingof the petition. Fed. R. Bankr. P. 1006(b). The$46 administrative fee may be paid ininstallments in the same manner as the filingfee. If a joint petition is filed, only one filingfee and one administrative fee are charged.Debtors should be aware that failure to paythese fees may result in dismissal of the case.11 U.S.C. § 1112(b)(10).

The voluntary petition will include standardinformation concerning the debtor’s name(s),social security number or tax identificationnumber, residence, location of principal assets(if a business), the debtor’s plan or intentionto file a plan, and a request for relief under theappropriate chapter of the Bankruptcy Code.Upon filing a voluntary petition for reliefunder chapter 11 or, in an involuntary case,the entry of an order for relief, the debtorautomatically assumes an additional identityas the “debtor in possession.” 11 U.S.C. § 1101. The term refers to a debtor that keepspossession and control of its assets whileundergoing a reorganization under chapter 11,without the appointment of a case trustee. Adebtor will remain a debtor in possession untilthe debtor’s plan of reorganization isconfirmed, the debtor’s case is dismissed orconverted to chapter 7, or a chapter 11 trusteeis appointed. The appointment or election ofa trustee occurs only in a small number ofcases. Generally, the debtor, as “debtor inpossession,” operates the business andperforms many of the functions that a trusteeperforms in cases under other chapters. 11U.S.C. § 1107(a).

Generally, a written disclosure statement anda plan of reorganization must be filed with thecourt. 11 U.S.C. §§ 1121, 1125. Thedisclosure statement is a document that mustcontain information concerning the assets,

liabilities, and business affairs of the debtorsufficient to enable a creditor to make aninformed judgment about the debtor’s plan ofreorganization. 11 U.S.C. § 1125. Theinformation required is governed by judicialdiscretion and the circumstances of the case.In a “small business case” (discussed below)the debtor may not need to file a separatedisclosure statement if the court determinesthat adequate information is contained in theplan. 11 U.S.C. § 1125(f). The contents of theplan must include a classification of claimsand must specify how each class of claimswill be treated under the plan. 11 U.S.C. § 1123. Creditors whose claims are“impaired,” i.e., those whose contractualrights are to be modified or who will be paidless than the full value of their claims underthe plan, vote on the plan by ballot. 11 U.S.C.§ 1126. After the disclosure statement isapproved by the court and the ballots arecollected and tallied, the court will conduct aconfirmation hearing to determine whether toconfirm the plan.11 U.S.C. § 1128.

In the case of individuals, chapter 11 bearssome similarities to chapter 13. For example,property of the estate for an individual debtorincludes the debtor’s earnings and propertyacquired by the debtor after filing until thecase is closed, dismissed or converted;funding of the plan may be from the debtor’sfuture earnings; and the plan cannot beconfirmed over a creditor’s objection withoutcommitting all of the debtor’s disposableincome over five years unless the plan paysthe claim in full, with interest, over a shorterperiod of time. 11 U.S.C. §§ 1115,1123(a)(8), 1129(a)(15).

31THE CHAPTER 11 DEBTOR INPOSSESSION

Chapter 11 is typically used to reorganize abusiness, which may be a corporation, soleproprietorship, or partnership. A corporationexists separate and apart from its owners, thestockholders. The chapter 11 bankruptcy caseof a corporation (corporation as debtor) doesnot put the personal assets of the stockholdersat risk other than the value of their investmentin the company’s stock. A sole proprietorship(owner as debtor), on the other hand, does nothave an identity separate and distinct from itsowner(s). Accordingly, a bankruptcy caseinvolving a sole proprietorship includes boththe business and personal assets of theowners-debtors. Like a corporation, apartnership exists separate and apart from itspartners. In a partnership bankruptcy case(partnership as debtor), however, the partners’personal assets may, in some cases, be used topay creditors in the bankruptcy case or thepartners, themselves, may be forced to file forbankruptcy protection.

Section 1107 of the Bankruptcy Code placesthe debtor in possession in the position of afiduciary, with the rights and powers of achapter 11 trustee, and it requires the debtor toperform of all but the investigative functionsand duties of a trustee. These duties, set forthin the Bankruptcy Code and Federal Rules ofBankruptcy Procedure, include accounting forproperty, examining and objecting to claims,and filing informational reports as required bythe court and the U.S. trustee or bankruptcyadministrator (discussed below), such asmonthly operating reports. 11 U.S.C. §§ 1106,1107; Fed. R. Bankr. P. 2015(a). The debtorin possession also has many of the otherpowers and duties of a trustee, including theright, with the court's approval, to employattorneys, accountants, appraisers,

auctioneers, or other professional persons toassist the debtor during its bankruptcy case.Other responsibilities include filing taxreturns and reports which are either necessaryor ordered by the court after confirmation,such as a final accounting. The U.S. trustee isresponsible for monitoring the compliance ofthe debtor in possession with the reportingrequirements.

Railroad reorganizations have specificrequirements under subsection IV of chapter11, which will not be addressed here. Inaddition, stock and commodity brokers areprohibited from filing under chapter 11 andare restricted to chapter 7. 11 U.S.C. § 109(d).

THE U.S. TRUSTEE OR BANKRUPTCYADMINISTRATOR

The U.S. trustee plays a major role inmonitoring the progress of a chapter 11 caseand supervising its administration. The U.S.trustee is responsible for monitoring thedebtor in possession’s operation of thebusiness and the submission of operatingreports and fees. Additionally, the U.S. trusteemonitors applications for compensation andreimbursement by professionals, plans anddisclosure statements filed with the court, andcreditors’ committees. The U.S. trusteeconducts a meeting of the creditors, oftenreferred to as the “section 341 meeting,” in achapter 11 case. 11 U.S.C. § 341. The U.S.trustee and creditors may question the debtorunder oath at the section 341 meetingconcerning the debtor’s acts, conduct,property, and the administration of the case.

The U.S. trustee also imposes certainrequirements on the debtor in possessionconcerning matters such as reporting itsmonthly income and operating expenses,establishing new bank accounts, and paying

32current employee withholding and other taxes.By law, the debtor in possession must pay aquarterly fee to the U.S. trustee for eachquarter of a year until the case is converted ordismissed. 28 U.S.C. § 1930(a)(6). Theamount of the fee, which may range from$250 to $10,000, depends on the amount ofthe debtor’s disbursements during eachquarter. Should a debtor in possession fail tocomply with the reporting requirements of theU.S. trustee or orders of the bankruptcy court,or fail to take the appropriate steps to bringthe case to confirmation, the U.S. trustee mayfile a motion with the court to have thedebtor’s chapter 11 case converted to anotherchapter of the Bankruptcy Code or to have thecase dismissed.

In North Carolina and Alabama, bankruptcyadministrators perform similar functions thatU.S. trustees perform in the remaining forty-eight states. The bankruptcy administratorprogram is administered by theAdministrative Office of the United StatesCourts, while the U.S. trustee program isadministered by the Department of Justice.For purposes of this publication, references toU.S. trustees are also applicable to bankruptcyadministrators.

CREDITORS’ COMMITTEES

Creditors’ committees can play a major role inchapter 11 cases. The committee is appointedby the U.S. trustee and ordinarily consists ofunsecured creditors who hold the sevenlargest unsecured claims against the debtor.11 U.S.C. § 1102. Among other things, thecommittee: consults with the debtor inpossession on administration of the case;investigates the debtor’s conduct andoperation of the business; and participates informulating a plan. 11 U.S.C. § 1103. Acreditors’ committee may, with the court’s

approval, hire an attorney or otherprofessionals to assist in the performance ofthe committee’s duties. A creditors’committee can be an important safeguard tothe proper management of the business by thedebtor in possession.

THE SMALL BUSINESS CASE ANDTHE SMALL BUSINESS DEBTOR

In some smaller cases the U.S. trustee may beunable to find creditors willing to serve on acreditors’ committee, or the committee maynot be actively involved in the case. TheBankruptcy Code addresses this issue bytreating a “small business case” somewhatdifferently than a regular bankruptcy case. Asmall business case is defined as a case with a“small business debtor.” 11 U.S.C. § 101(51C). Determination of whether adebtor is a “small business debtor” requiresapplication of a two-part test. First, the debtormust be engaged in commercial or businessactivities (other than primarily owning oroperating real property) with total non-contingent liquidated secured and unsecureddebts of $2,343,300 or less. Second, thedebtor’s case must be one in which the U.S.trustee has not appointed a creditors’committee, or the court has determined thecreditors’ committee is insufficiently activeand representative to provide oversight of thedebtor. 11 U.S.C. § 101(51D).

In a small business case, the debtor inpossession must, among other things, attachthe most recently prepared balance sheet,statement of operations, cash-flow statementand most recently filed tax return to thepetition or provide a statement under oathexplaining the absence of such documents andmust attend court and the U.S. trustee meetingthrough senior management personnel andcounsel. The small business debtor must make

33ongoing filings with the court concerning itsprofitability and projected cash receipts anddisbursements, and must report whether it isin compliance with the Bankruptcy Code andthe Federal Rules of Bankruptcy Procedureand whether it has paid its taxes and filed itstax returns. 11 U.S.C. §§ 308, 1116.

In contrast to other chapter 11 debtors, thesmall business debtor is subject to additionaloversight by the U.S. trustee. Early in thecase, the small business debtor must attend an“initial interview” with the U.S. trustee atwhich time the U.S. trustee will evaluate thedebtor’s viability, inquire about the debtor’sbusiness plan, and explain certain debtorobligations including the debtor’sresponsibility to file various reports. 28U.S.C. § 586(a)(7). The U.S. trustee will alsomonitor the activities of the small businessdebtor during the case to identify as promptlyas possible whether the debtor will be unableto confirm a plan.

Because certain filing deadlines are differentand extensions are more difficult to obtain, acase designated as a small business casenormally proceeds more quickly than otherchapter 11 cases. For example, only the debtormay file a plan during the first 180 days of asmall business case. 11 U.S.C. § 1121(e). This“exclusivity period” may be extended by thecourt, but only to 300 days, and only if thedebtor demonstrates by a preponderance ofthe evidence that the court will confirm a planwithin a reasonable period of time. When thecase is not a small business case, however, thecourt may extend the exclusivity period “forcause” up to 18 months.

THE SINGLE ASSET REAL ESTATEDEBTOR

Single asset real estate debtors are subject tospecial provisions of the Bankruptcy Code.The term “single asset real estate” is definedas “a single property or project, other thanresidential real property with fewer than fourresidential units, which generates substantiallyall of the gross income of a debtor who is nota family farmer and on which no substantialbusiness is being conducted by a debtor otherthan the business of operating the realproperty and activities incidental.” 11 U.S.C.§ 101(51B). The Bankruptcy Code providescircumstances under which creditors of asingle asset real estate debtor may obtainrelief from the automatic stay which are notavailable to creditors in ordinary bankruptcycases. 11 U.S.C. § 362(d). On request of acreditor with a claim secured by the singleasset real estate and after notice and a hearing,the court will grant relief from the automaticstay to the creditor unless the debtor files afeasible plan of reorganization or beginsmaking interest payments to the creditorwithin 90 days from the date of the filing ofthe case, or within 30 days of the court’sdetermination that the case is a single assetreal estate case. The interest payments mustbe equal to the non-default contract interestrate on the value of the creditor’s interest inthe real estate. 11 U.S.C. § 362(d)(3).

APPOINTMENT OR ELECTION OF ACASE TRUSTEE

Although the appointment of a case trustee isa rarity in a chapter 11 case, a party in interestor the U.S. trustee can request theappointment of a case trustee or examiner atany time prior to confirmation in a chapter 11case. The court, on motion by a party ininterest or the U.S. trustee and after notice andhearing, shall order the appointment of a casetrustee for cause, including fraud, dishonesty,incompetence, or gross mismanagement, or if

34such an appointment is in the interest ofcreditors, any equity security holders, andother interests of the estate. 11 U.S.C. § 1104(a). Moreover, the U.S. trustee isrequired to move for appointment of a trusteeif there are reasonable grounds to believe thatany of the parties in control of the debtor“participated in actual fraud, dishonesty orcriminal conduct in the management of thedebtor or the debtor’s financial reporting.” 11U.S.C. § 1104(e). The trustee is appointed bythe U.S. trustee, after consultation with partiesin interest and subject to the court’s approval.Fed. R. Bankr. P. 2007.1. Alternatively, atrustee in a case may be elected if a party ininterest requests the election of a trusteewithin 30 days after the court orders theappointment of a trustee. In that instance, theU.S. trustee convenes a meeting of creditorsfor the purpose of electing a person to serve astrustee in the case. 11 U.S.C. § 1104(b).

The case trustee is responsible formanagement of the property of the estate,operation of the debtor’s business, and, ifappropriate, the filing of a plan ofreorganization. Section 1106 of theBankruptcy Code requires the trustee to file aplan “as soon as practicable” or, alternatively,to file a report explaining why a plan will notbe filed or to recommend that the case beconverted to another chapter or dismissed. 11U.S.C. § 1106(a)(5).

Upon the request of a party in interest or theU.S. trustee, the court may terminate thetrustee’s appointment and restore the debtor inpossession to management of bankruptcyestate at any time before confirmation.11U.S.C. § 1105.

THE ROLE OF AN EXAMINER

The appointment of an examiner in a chapter11 case is rare. The role of an examiner isgenerally more limited than that of a trustee.The examiner is authorized to perform theinvestigatory functions of the trustee and isrequired to file a statement of anyinvestigation conducted. If ordered to do so bythe court, however, an examiner may carry outany other duties of a trustee that the courtorders the debtor in possession not to perform.11 U.S.C. § 1106. Each court has theauthority to determine the duties of anexaminer in each particular case. In somecases, the examiner may file a plan ofreorganization, negotiate or help the partiesnegotiate, or review the debtor’s schedules todetermine whether some of the claims areimproperly categorized. Sometimes, theexaminer may be directed to determine ifobjections to any proofs of claim should befiled or whether causes of action havesufficient merit so that further legal actionshould be taken. The examiner may notsubsequently serve as a trustee in the case. 11U.S.C. § 321.

THE AUTOMATIC STAY

The automatic stay provides a period of timein which all judgments, collection activities,foreclosures, and repossessions of propertyare suspended and may not be pursued by thecreditors on any debt or claim that arosebefore the filing of the bankruptcy petition. Aswith cases under other chapters of theBankruptcy Code, a stay of creditor actionsagainst the chapter 11 debtor automaticallygoes into effect when the bankruptcy petitionis filed. 11 U.S.C. § 362(a). The filing of apetition, however, does not operate as a stayfor certain types of actions listed under 11U.S.C. § 362(b). The stay provides abreathing spell for the debtor, during whichnegotiations can take place to try to resolve

35the difficulties in the debtor’s financialsituation.

Under specific circumstances, the securedcreditor can obtain an order from the courtgranting relief from the automatic stay. Forexample, when the debtor has no equity in theproperty and the property is not necessary foran effective reorganization, the securedcreditor can seek an order of the court liftingthe stay to permit the creditor to foreclose onthe property, sell it, and apply the proceeds tothe debt. 11 U.S.C. § 362(d).

The Bankruptcy Code permits applications forfees to be made by certain professionalsduring the case. Thus, a trustee, a debtor’sattorney, or any professional person appointedby the court may apply to the court atintervals of 120 days for interimcompensation and reimbursement payments.In very large cases with extensive legal work,the court may permit more frequentapplications. Although professional fees maybe paid if authorized by the court, the debtorcannot make payments to professionalcreditors on prepetition obligations, i.e.,obligations which arose before the filing ofthe bankruptcy petition. The ordinaryexpenses of the ongoing business, however,continue to be paid.

WHO CAN FILE A PLAN

The debtor (unless a “small business debtor”)has a 120-day period during which it has anexclusive right to file a plan. 11 U.S.C. § 1121(b). This exclusivity period may beextended or reduced by the court. But, in noevent, may the exclusivity period, includingall extensions, be longer than 18 months. 11U.S.C. § 1121(d). After the exclusivity periodhas expired, a creditor or the case trustee may

file a competing plan. The U.S. trustee maynot file a plan. 11 U.S.C. § 307.

A chapter 11 case may continue for manyyears unless the court, the U.S. trustee, thecommittee, or another party in interest acts toensure the case’s timely resolution. Thecreditors’ right to file a competing planprovides incentive for the debtor to file a planwithin the exclusivity period and acts as acheck on excessive delay in the case.

AVOIDABLE TRANSFERS

The debtor in possession or the trustee, as thecase may be, has what are called “avoiding”powers. These powers may be used to undo atransfer of money or property made during acertain period of time before the filing of thebankruptcy petition. By avoiding a particulartransfer of property, the debtor in possessioncan cancel the transaction and force the returnor “disgorgement” of the payments orproperty, which then are available to pay allcreditors. Generally, and subject to variousdefenses, the power to avoid transfers iseffective against transfers made by the debtorwithin 90 days before filing the petition. Buttransfers to “insiders” (i.e., relatives, generalpartners, and directors or officers of thedebtor) made up to a year before filing may beavoided. 11 U.S.C. §§ 101(31), 101(54), 547,548. In addition, under 11 U.S.C. § 544, thetrustee is authorized to avoid transfers underapplicable state law, which often provides forlonger time periods. Avoiding powers preventunfair prepetition payments to one creditor atthe expense of all other creditors.

36CASH COLLATERAL, ADEQUATEPROTECTION, AND OPERATINGCAPITAL

Although the preparation, confirmation, andimplementation of a plan of reorganization isat the heart of a chapter 11 case, other issuesmay arise that must be addressed by thedebtor in possession. The debtor in possessionmay use, sell, or lease property of the estate inthe ordinary course of its business, withoutprior approval, unless the court ordersotherwise. 11 U.S.C. § 363(c). If the intendedsale or use is outside the ordinary course of itsbusiness, the debtor must obtain permissionfrom the court.

A debtor in possession may not use “cashcollateral” without the consent of the securedparty or authorization by the court, whichmust first examine whether the interest of thesecured party is adequately protected. 11U.S.C. § 363. Section 363 defines “cashcollateral” as cash, negotiable instruments,documents of title, securities, depositaccounts, or other cash equivalents, wheneveracquired, in which the estate and an entityother than the estate have an interest. Itincludes the proceeds, products, offspring,rents, or profits of property and the fees,charges, accounts or payments for the use oroccupancy of rooms and other public facilitiesin hotels, motels, or other lodging propertiessubject to a creditor’s security interest.

When “cash collateral” is used (spent), thesecured creditors are entitled to receiveadditional protection under section 363 of theBankruptcy Code. The debtor in possessionmust file a motion requesting an order fromthe court authorizing the use of the cashcollateral. Pending consent of the securedcreditor or court authorization for the debtorin possession’s use of cash collateral, the

debtor in possession must segregate andaccount for all cash collateral in itspossession. 11 U.S.C. § 363(c)(4). A partywith an interest in property being used by thedebtor may request that the court prohibit orcondition this use to the extent necessary toprovide “adequate protection” to the creditor.

Adequate protection may be required toprotect the value of the creditor’s interest inthe property being used by the debtor inpossession. This is especially important whenthere is a decrease in value of the property.The debtor may make periodic or lump sumcash payments, or provide an additional orreplacement lien that will result in thecreditor’s property interest being adequatelyprotected. 11 U.S.C. § 361.

When a chapter 11 debtor needs operatingcapital, it may be able to obtain it from alender by giving the lender a court-approved“superpriority” over other unsecured creditorsor a lien on property of the estate. 11 U.S.C.§ 364.

MOTIONS

Before confirmation of a plan, severalactivities may take place in a chapter 11 case.Continued operation of the debtor’s businessmay lead to the filing of a number ofcontested motions. The most common arethose seeking relief from the automatic stay,the use of cash collateral, or to obtain credit.There may also be litigation over executory(i.e., unfulfilled) contracts and unexpiredleases and the assumption or rejection of thoseexecutory contracts and unexpired leases bythe debtor in possession. 11 U.S.C. § 365.Delays in formulating, filing, and obtainingconfirmation of a plan often prompt creditorsto file motions for relief from stay, to convert

37the case to chapter 7, or to dismiss the casealtogether.

ADVERSARY PROCEEDINGS

Frequently, the debtor in possession willinstitute a lawsuit, known as an adversaryproceeding, to recover money or property forthe estate. Adversary proceedings may takethe form of lien avoidance actions, actions toavoid preferences, actions to avoid fraudulenttransfers, or actions to avoid post-petitiontransfers. These proceedings are governed byPart VII of the Federal Rules of BankruptcyProcedure. At times, a creditors’ committeemay be authorized by the bankruptcy court topursue these actions against insiders of thedebtor if the plan provides for the committeeto do so or if the debtor has refused a demandto do so. Creditors may also initiate adversaryproceedings by filing complaints to determinethe validity or priority of a lien, revoke anorder confirming a plan, determine thedischargeability of a debt, obtain aninjunction, or subordinate a claim of anothercreditor.

CLAIMS

The Bankruptcy Code defines a claim as: (1)a right to payment; (2) or a right to anequitable remedy for a failure of performanceif the breach gives rise to a right to payment.11 U.S.C. § 101(5). Generally, any creditorwhose claim is not scheduled (i.e., listed bythe debtor on the debtor’s schedules) or isscheduled as disputed, contingent, orunliquidated must file a proof of claim (andattach evidence documenting the claim) inorder to be treated as a creditor for purposesof voting on the plan and distribution under it.Fed. R. Bankr. P. 3003(c)(2). But filing aproof of claim is not necessary if thecreditor’s claim is scheduled (but is not listed

as disputed, contingent, or unliquidated by thedebtor) because the debtor’s schedules aredeemed to constitute evidence of the validityand amount of those claims. 11 U.S.C. § 1111.If a scheduled creditor chooses to file a claim,a properly filed proof of claim supersedes anyscheduling of that claim. Fed. R. Bankr. P.3003(c)(4). It is the responsibility of thecreditor to determine whether the claim isaccurately listed on the debtor’s schedules.The debtor must provide notification to thosecreditors whose names are added and whoseclaims are listed as a result of an amendmentto the schedules. The notification also shouldadvise such creditors of their right to fileproofs of claim and that their failure to do somay prevent them from voting upon thedebtor’s plan of reorganization orparticipating in any distribution under thatplan. When a debtor amends the schedule ofliabilities to add a creditor or change thestatus of any claims to disputed, contingent, orunliquidated, the debtor must provide noticeof the amendment to any entity affected. Fed.R. Bankr. P. 1009(a).

EQUITY SECURITY HOLDERS

An equity security holder is a holder of anequity security of the debtor. Examples of anequity security are a share in a corporation, aninterest of a limited partner in a limitedpartnership, or a right to purchase, sell, orsubscribe to a share, security, or interest of ashare in a corporation or an interest in alimited partnership. 11 U.S.C. § 101(16), (17).An equity security holder may vote on theplan of reorganization and may file a proof ofinterest, rather than a proof of claim. A proofof interest is deemed filed for any interest thatappears in the debtor’s schedules, unless it isscheduled as disputed, contingent, orunliquidated. 11 U.S.C. § 1111. An equitysecurity holder whose interest is not scheduled

38or scheduled as disputed, contingent, orunliquidated must file a proof of interest inorder to be treated as a creditor for purposesof voting on the plan and distribution under it.Fed. R. Bankr. P. 3003(c)(2). A properly filedproof of interest supersedes any scheduling ofthat interest. Fed. R. Bankr. P. 3003(c)(4).Generally, most of the provisions that apply toproofs of claim, as discussed above, are alsoapplicable to proofs of interest.

CONVERSION OR DISMISSAL

A debtor in a case under chapter 11 has a one-time absolute right to convert the chapter 11case to a case under chapter 7 unless: (1) thedebtor is not a debtor in possession; (2) thecase originally was commenced as aninvoluntary case under chapter 11; or (3) thecase was converted to a case under chapter 11other than at the debtor’s request. 11 U.S.C. § 1112(a). A debtor in a chapter 11 case doesnot have an absolute right to have the casedismissed upon request.

A party in interest may file a motion todismiss or convert a chapter 11 case to achapter 7 case “for cause.” Generally, if causeis established after notice and hearing, thecourt must convert or dismiss the case(whichever is in the best interests of creditorsand the estate) unless it specifically finds thatthe requested conversion or dismissal is not inthe best interest of creditors and the estate. 11U.S.C. § 1112(b). Alternatively, the court maydecide that appointment of a chapter 11trustee or an examiner is in the best interestsof creditors and the estate. 11 U.S.C. § 1104(a)(3). Section 1112(b)(4) of theBankruptcy Code sets forth numerousexamples of cause that would supportdismissal or conversion. For example, themoving party may establish cause by showingthat there is substantial or continuing loss to

the estate and the absence of a reasonablelikelihood of rehabilitation; grossmismanagement of the estate; failure tomaintain insurance that poses a risk to theestate or the public; or unauthorized use ofcash collateral that is substantially harmful toa creditor.

Cause for dismissal or conversion alsoincludes an unexcused failure to timelycomply with reporting and filingrequirements; failure to attend the meeting ofcreditors or attend a Fed. R. Bankr. P. 2004examination without good cause; failure totimely provide information to the U.S. trustee;and failure to timely pay post-petition taxes ortimely file post-petition returns. Additionally,failure to file a disclosure statement or to fileand confirm a plan within the time fixed bythe Bankruptcy Code or order of the court;inability to effectuate a plan; denial orrevocation of confirmation; inability toconsummate a confirmed plan represent“cause” for dismissal under the statute. In anindividual case, failure of the debtor to paypost-petition domestic support obligationsconstitutes “cause” for dismissal orconversion.

Section 1112(c) of the Bankruptcy Codeprovides an important exception to theconversion process in a chapter 11 case.Under this provision, the court is prohibitedfrom converting a case involving a farmer orcharitable institution to a liquidation caseunder chapter 7 unless the debtor requests theconversion.

THE DISCLOSURE STATEMENT

Generally, the debtor (or any plan proponent)must file and get court approval of a writtendisclosure statement before there can be avote on the plan of reorganization. The

39disclosure statement must provide “adequateinformation” concerning the affairs of thedebtor to enable the holder of a claim orinterest to make an informed judgment aboutthe plan. 11 U.S.C. § 1125. In a smallbusiness case, however, the court maydetermine that the plan itself containsadequate information and that a separatedisclosure statement is unnecessary. 11 U.S.C.§ 1125(f). After the disclosure statement isfiled, the court must hold a hearing todetermine whether the disclosure statementshould be approved. Acceptance or rejectionof a plan usually cannot be solicited until thecourt has first approved the written disclosurestatement. 11 U.S.C. § 1125(b). An exceptionto this rule exists if the initial solicitation ofthe party occurred before the bankruptcyfiling, as would be the case in so-called“prepackaged” bankruptcy plans (i.e., wherethe debtor negotiates a plan with significantcreditor constituencies before filing forbankruptcy). Continued post-filing solicitationof such parties is not prohibited. After thecourt approves the disclosure statement, thedebtor or proponent of a plan can begin tosolicit acceptances of the plan, and creditorsmay also solicit rejections of the plan.

Upon approval of a disclosure statement, theplan proponent must mail the following to theU.S. trustee and all creditors and equitysecurity holders: (1) the plan, or a courtapproved summary of the plan; (2) thedisclosure statement approved by the court;(3) notice of the time within whichacceptances and rejections of the plan may befiled; and (4) such other information as thecourt may direct, including any opinion of thecourt approving the disclosure statement or acourt-approved summary of the opinion. Fed.R. Bankr. P. 3017(d). In addition, the debtormust mail to the creditors and equity securityholders entitled to vote on the plan or plans:

(1) notice of the time fixed for filingobjections; (2) notice of the date and time forthe hearing on confirmation of the plan; and(3) a ballot for accepting or rejecting the planand, if appropriate, a designation for thecreditors to identify their preference amongcompeting plans. Id. But in a small businesscase, the court may conditionally approve adisclosure statement subject to final approvalafter notice and a combined disclosurestatement/plan confirmation hearing. 11U.S.C. § 1125(f).

ACCEPTANCE OF THE PLAN OFREORGANIZATION

As noted earlier, only the debtor may file aplan of reorganization during the first 120-dayperiod after the petition is filed (or after entryof the order for relief, if an involuntarypetition was filed). The court may grantextension of this exclusive period up to 18months after the petition date. In addition, thedebtor has 180 days after the petition date orentry of the order for relief to obtainacceptances of its plan. 11 U.S.C. § 1121. Thecourt may extend (up to 20 months) or reducethis acceptance exclusive period for cause. 11U.S.C. § 1121(d). In practice, debtorstypically seek extensions of both the planfiling and plan acceptance deadlines at thesame time so that any order sought from thecourt allows the debtor two months to seekacceptances after filing a plan before anycompeting plan can be filed.

If the exclusive period expires before thedebtor has filed and obtained acceptance of aplan, other parties in interest in a case, such asthe creditors’ committee or a creditor, mayfile a plan. Such a plan may compete with aplan filed by another party in interest or by thedebtor. If a trustee is appointed, the trusteemust file a plan, a report explaining why the

40trustee will not file a plan, or arecommendation for conversion or dismissalof the case. 11 U.S.C. § 1106(a)(5). Aproponent of a plan is subject to the samerequirements as the debtor with respect todisclosure and solicitation.

In a chapter 11 case, a liquidating plan ispermissible. Such a plan often allows thedebtor in possession to liquidate the businessunder more economically advantageouscircumstances than a chapter 7 liquidation. Italso permits the creditors to take a more activerole in fashioning the liquidation of the assetsand the distribution of the proceeds than in achapter 7 case.

Section 1123(a) of the Bankruptcy Code liststhe mandatory provisions of a chapter 11 plan,and section 1123(b) lists the discretionaryprovisions. Section 1123(a)(1) provides that achapter 11 plan must designate classes ofclaims and interests for treatment under thereorganization. Generally, a plan will classifyclaim holders as secured creditors, unsecuredcreditors entitled to priority, generalunsecured creditors, and equity securityholders.

Under section 1126(c) of the BankruptcyCode, an entire class of claims is deemed toaccept a plan if the plan is accepted bycreditors that hold at least two-thirds inamount and more than one-half in number ofthe allowed claims in the class. Under section1129(a)(10), if there are impaired classes ofclaims, the court cannot confirm a plan unlessit has been accepted by at least one class ofnon-insiders who hold impaired claims (i.e.,claims that are not going to be paidcompletely or in which some legal, equitable,or contractual right is altered). Moreover,under section 1126(f), holders of unimpairedclaims are deemed to have accepted the plan.

Under section 1127(a) of the BankruptcyCode, the plan proponent may modify the planat any time before confirmation, but the planas modified must meet all the requirements ofchapter 11. When there is a proposedmodification after balloting has beenconducted, and the court finds after a hearingthat the proposed modification does notadversely affect the treatment of any creditorwho has not accepted the modification inwriting, the modification is deemed to havebeen accepted by all creditors who previouslyaccepted the plan. Fed. R. Bankr. P. 3019. Ifit is determined that the proposedmodification does have an adverse effect onthe claims of non-consenting creditors, thenanother balloting must take place.

Because more than one plan may be submittedto the creditors for approval, every proposedplan and modification must be dated andidentified with the name of the entity orentities submitting the plan or modification.Fed. R. Bankr. P. 3016(b). When competingplans are presented that meet the requirementsfor confirmation, the court must consider thepreferences of the creditors and equitysecurity holders in determining which plan toconfirm.

Any party in interest may file an objection toconfirmation of a plan. The Bankruptcy Coderequires the court, after notice, to hold ahearing on confirmation of a plan. If noobjection to confirmation has been timelyfiled, the Bankruptcy Code allows the court todetermine whether the plan has been proposedin good faith and according to law. Fed. R.Bankr. P. 3020(b)(2). Before confirmation canbe granted, the court must be satisfied thatthere has been compliance with all the otherrequirements of confirmation set forth insection 1129 of the Bankruptcy Code, even inthe absence of any objections. In order to

41confirm the plan, the court must find, amongother things, that: (1) the plan is feasible; (2)it is proposed in good faith; and (3) the planand the proponent of the plan are incompliance with the Bankruptcy Code. Inorder to satisfy the feasibility requirement, thecourt must find that confirmation of the planis not likely to be followed by liquidation(unless the plan is a liquidating plan) or theneed for further financial reorganization.

THE DISCHARGE

Section 1141(d)(1) generally provides thatconfirmation of a plan discharges a debtorfrom any debt that arose before the date ofconfirmation. After the plan is confirmed, thedebtor is required to make plan payments andis bound by the provisions of the plan ofreorganization. The confirmed plan createsnew contractual rights, replacing orsuperseding pre-bankruptcy contracts.

There are, of course, exceptions to the generalrule that an order confirming a plan operatesas a discharge. Confirmation of a plan ofreorganization discharges any type of debtor– corporation, partnership, or individual –from most types of prepetition debts. It doesnot, however, discharge an individual debtorfrom any debt made nondischargeable bysection 523 of the Bankruptcy Code.1

Moreover, except in limited circumstances, adischarge is not available to an individualdebtor unless and until all payments havebeen made under the plan. 11 U.S.C. §1141(d)(5). Confirmation does not dischargethe debtor if the plan is a liquidation plan, asopposed to one of reorganization, unless thedebtor is an individual. When the debtor is anindividual, confirmation of a liquidation planwill result in a discharge (after plan paymentsare made) unless grounds would exist fordenying the debtor a discharge if the case

were proceeding under chapter 7 instead ofchapter 11. 11 U.S.C. §§ 727(a), 1141(d).

POSTCONFIRMATIONMODIFICATION OF THE PLAN

At any time after confirmation and before“substantial consummation” of a plan, theproponent of a plan may modify the plan if themodified plan would meet certain BankruptcyCode requirements. 11 U.S.C. § 1127(b). Thisshould be distinguished from preconfirmationmodification of the plan. A modifiedpostconfirmation plan does not automaticallyb e c o me t h e p l a n . A mo d i f i e dpostconfirmation plan in a chapter 11 casebecomes the plan only “if circumstanceswarrant such modification” and the court,after notice and hearing, confirms the plan asmodified. If the debtor is an individual, theplan may be modified postconfirmation uponthe request of the debtor, the trustee, the U.S.trustee, or the holder of an allowed unsecuredclaim to make adjustments to payments dueunder the plan. 11 U.S.C. § 1127(e).

POSTCONFIRMATIONADMINISTRATION

Notwithstanding the entry of the confirmationorder, the court has the authority to issue anyother order necessary to administer the estate.Fed. R. Bankr. P. 3020(d). This authoritywould include the postconfirmationdetermination of objections to claims oradversary proceedings, which must beresolved before a plan can be fullyconsummated. Sections 1106(a)(7) and1107(a) of the Bankruptcy Code require adebtor in possession or a trustee to report onthe progress made in implementing a planafter confirmation. A chapter 11 trustee ordebtor in possession has a number ofresponsibilities to perform after confirmation,

42including consummating the plan, reportingon the status of consummation, and applyingfor a final decree.

REVOCATION OF THECONFIRMATION ORDER

Revocation of the confirmation order is anundoing or cancellation of the confirmation ofa plan. A request for revocation ofconfirmation, if made at all, must be made bya party in interest within 180 days ofconfirmation. The court, after notice andhearing, may revoke a confirmation order “ifand only if the [confirmation] order wasprocured by fraud.” 11 U.S.C. § 1144.

THE FINAL DECREE

A final decree closing the case must beentered after the estate has been “fullyadministered.” Fed. R. Bankr. P. 3022. Localbankruptcy court policies generally determinewhen the final decree is entered and the caseclosed.

NOTES

1. Debts not discharged include debts foralimony and child support, certain taxes, debtsfor certain educational benefit overpaymentsor loans made or guaranteed by agovernmental unit, debts for willful andmalicious injury by the debtor to anotherentity or to the property of another entity,debts for death or personal injury caused bythe debtor’s operation of a motor vehiclewhile the debtor was intoxicated from alcoholor other substances, and debts for certaincriminal restitution orders.11 U.S.C. § 523(a).The debtor will continue to be liable for thesetypes of debts to the extent that they are notpaid in the chapter 11 case. Debts for moneyor property obtained by false pretenses, debts

for fraud or defalcation while acting in afiduciary capacity, and debts for willful andmalicious injury by the debtor to anotherentity or to the property of another entity willbe discharged unless a creditor timely filesand prevails in an action to have such debtsdeclared nondischargeable. 11 U.S.C. § 523(c); Fed. R. Bankr. P. 4007(c).

43

Chapter 12

Family Farmer or Family FishermanBankruptcy

BACKGROUND

Chapter 12 is designed for “family farmers” or“family fishermen” with “regular annualincome.” It enables financially distressedfamily farmers and fishermen to propose andcarry out a plan to repay all or part of theirdebts. Under chapter 12, debtors propose arepayment plan to make installments tocreditors over three to five years. Generally,the plan must provide for payments overthree years unless the court approves a longerperiod “for cause.” But unless the planproposes to pay 100% of domestic supportclaims (i.e., child support and alimony) if anyexist, it must be for five years and mustinclude all of the debtor’s disposable income.In no case may a plan provide for paymentsover a period longer than five years. 11 U.S.C.§ 1222(b)-(c).

In tailoring bankruptcy law to meet theeconomic realities of family farming and thefamily fisherman, chapter 12 eliminates manyof the barriers such debtors would face ifseeking to reorganize under either chapter 11or 13 of the Bankruptcy Code. For example,chapter 12 is more streamlined, lesscomplicated, and less expensive than chapter11, which is better suited to large corporatereorganizations. In addition, few familyfarmers or fishermen find chapter 13 to beadvantageous because it is designed for wageearners who have smaller debts than thosefacing family farmers. In chapter 12, Congresssought to combine the features of theBankruptcy Code which can provide a

framework for successful family farmer andfisherman reorganizations.

The Bankruptcy Code provides that only afamily farmer or family fisherman with“regular annual income” may file a petitionfor relief under chapter 12. 11 U.S.C.§§ 101(18), 101(19A), 109(f). The purpose ofthis requirement is to ensure that the debtor’sannual income is sufficiently stable andregular to permit the debtor to make paymentsunder a chapter 12 plan. But chapter 12 makesallowance for situations in which familyfarmers or fishermen have income that isseasonal in nature. Relief under chapter 12 isvoluntary, and only the debtor may file apetition under the chapter.

Under the Bankruptcy Code, “family farmers”and “family fishermen” fall into twocategories: (1) an individual or individual andspouse and (2) a corporation or partnership.Farmers or fishermen falling into the firstcategory must meet each of the following fourcriteria as of the date the petition is filed inorder to qualify for relief under chapter 12:

1. The individual or husband and wife mustbe engaged in a farming operation or acommercial fishing operation.

2. The total debts (secured and unsecured) ofthe operation must not exceed $3,792,650 (ifa farming operation) or $1,757,475 (if acommercial fishing operation).

3. If a family farmer, at least 50%, and iffamily fisherman at least 80%, of the totaldebts that are fixed in amount (exclusive ofdebt for the debtor’s home) must be related tothe farming or commercial fishing operation.

4. More than 50% of the gross income of theindividual or the husband and wife for the

44preceding tax year (or, for family farmersonly, for each of the 2nd and 3rd prior taxyears) must have come from the farming orcommercial fishing operation.

In order for a corporation or partnership to fallwithin the second category of debtors eligibleto file as family farmers or family fishermen,the corporation or partnership must meet eachof the following criteria as of the date of thefiling of the petition:

1. More than one-half the outstanding stock orequity in the corporation or partnership mustbe owned by one family or by one family andits relatives.

2. The family or the family and its relativesmust conduct the farming or commercialfishing operation.

3. More than 80% of the value of thecorporate or partnership assets must be relatedto the farming or fishing operation.

4. The total indebtedness of the corporation orpartnership must not exceed $3,792,650 (if afarming operation) or $1,757,475 (if acommercial fishing operation).

5. At least 50% for a farming operation or80% for a fishing operation of thecorporation’s or partnership’s total debtswhich are fixed in amount (exclusive of debtfor one home occupied by a shareholder) mustbe related to the farming or fishing operation.

6. If the corporation issues stock, the stockcannot be publicly traded.

A debtor cannot file under chapter 12 (or anyother chapter) if during the preceding 180days a prior bankruptcy petition wasdismissed due to the debtor’s willful failure to

appear before the court or comply with ordersof the court or was voluntarily dismissed aftercreditors sought relief from the bankruptcycourt to recover property upon which theyhold liens. 11 U.S.C. §§ 109(g), 362(d) and(e). In addition, no individual may be a debtorunder chapter 12 or any chapter of theBankruptcy Code unless he or she has, within180 days before filing, received creditcounseling from an approved creditcounseling agency either in an individual orgroup briefing. 11 U.S.C. §§ 109, 111. Thereare exceptions in emergency situations orwhere the U.S. trustee (or bankruptcyadministrator)1 has determined that there areinsufficient approved agencies to provide therequired counseling. If a debt managementplan is developed during required creditcounseling, it must be filed with the court.

HOW CHAPTER 12 WORKS

A chapter 12 case begins by filing a petitionwith the bankruptcy court serving the areawhere the individual lives or where thecorporation or partnership debtor has itsprincipal place of business or principal assets.Unless the court orders otherwise, the debtoralso shall file with the court (1) schedules ofassets and liabilities, (2) a schedule of currentincome and expenditures, (3) a schedule ofexecutory contracts and unexpired leases, and(4) a statement of financial affairs. Fed. R.Bankr. P. 1007(b). A husband and wife mayfile a joint petition or individual petitions. 11U.S.C. § 302(a). (The Official Forms may bepurchased at legal stationery stores ordownloaded from the internet at: http://www.uscourts.gov/bkforms/index.html.They are not available from the court.)

The courts must charge a $200 case filing feeand a $46 miscellaneous administrative fee.Normally the fees should be paid to the clerk

45of the court upon filing. With the court’spermission, however, they may be paid ininstallments. 28 U.S.C. § 1930(a); Fed. R.Bankr. P. 1006(b); Bankruptcy CourtMiscellaneous Fee Schedule, Item 8. Thenumber of such installments is limited to fourand the debtor must make the final installmentno later than 120 days after filing the petition.Fed. R. Bankr. P. 1006(b). For cause shown,the court may extend the time of anyinstallment, provided that the last installmentis paid not later than 180 days after the filingof the petition. Id. The debtor may also paythe $46 administrative fee in installments. If ajoint petition is filed, only one filing fee andone administrative fee are charged. Debtorsshould be aware that failure to pay these feesmay result in dismissal of the case. 11 U.S.C.§ 1208(c)(2).

In order to complete the Official BankruptcyForms which make up the petition, statementof financial affairs, and schedules, the debtorwill need to compile the followinginformation:

1. A list of all creditors and the amounts andnature of their claims;

2. The source, amount, and frequency of thedebtor’s income;

3. A list of all of the debtor’s property; and

4. A detailed list of the debtor’s monthlyfarming and living expenses, i.e., food,shelter, utilities, taxes, transportation,medicine, feed, fertilizer, etc.

Married individuals must gather thisinformation for each spouse regardless ofwhether they are filing a joint petition,separate individual petitions, or even if onlyone spouse is filing. In a situation where only

one spouse files, the income and expenses ofthe non-filing spouse is required so that thecourt, the trustee, and the creditors canevaluate the household’s financial position.

When a chapter 12 petition is filed, animpartial trustee is appointed to administer thecase. 11 U.S.C. § 1202. In some districts, theU.S. trustee appoints a standing trustee toserve in all chapter 12 cases. 28 U.S.C. § 586(b). As in chapter 13, the trustee bothevaluates the case and serves as a disbursingagent, collecting payments from the debtorand making distributions to creditors. 11U.S.C. § 1202.

Filing the petition under chapter 12“automatically stays” (stops) most collectionactions against the debtor or the debtor’sproperty. 11 U.S.C. § 362. Filing the petitiondoes not, however, stay certain types ofactions listed under 11 U.S.C. § 362(b). Thestay arises by operation of law and requires nojudicial action. As long as the stay is in effect,creditors generally cannot initiate or continueany lawsuits, wage garnishments, or eventelephone calls demanding payments. Thebankruptcy clerk gives notice of thebankruptcy case to all creditors whose namesand addresses are provided by the debtor.

Chapter 12 also contains a special automaticstay provision that protects co-debtors. Unlessthe bankruptcy court authorizes otherwise, acreditor may not seek to collect a “consumerdebt” from any individual who is liable withthe debtor. 11 U.S.C. § 1201(a). Consumerdebts are those incurred by an individualprimarily for a personal, family, or householdpurpose. 11 U.S.C. § 101(8).

Between 21 to 35 days after the petition isfiled, the chapter 12 trustee will hold a“meeting of creditors.” If the U.S. trustee or

46bankruptcy administrator schedules themeeting at a place that does not have regularU.S. trustee or bankruptcy administratorstaffing, the meeting may be held no morethan 60 days after the debtor files. During themeeting the trustee puts the debtor under oathand both the trustee and creditors may askquestions. The debtor must attend the meetingand answer questions regarding the debtor’sfinancial affairs and the proposed terms of thedebtor’s repayment plan. 11 U.S.C. § 343;Fed. R. Bankr. P. 4002. If a husband and wifehave filed a joint petition, they both mustattend the creditors’ meeting. In order topreserve their independent judgment,bankruptcy judges are prohibited fromattending. 11 U.S.C. § 341(c). The partiestypically resolve problems with the plan eitherduring or shortly after the creditors’ meeting.Generally, the debtor can avoid problems bymaking sure that the petition and plan arecomplete and accurate, and by consulting withthe trustee prior to the meeting.

In a chapter 12 case, to participate indistributions from the bankruptcy estate,unsecured creditors must file their claims withthe court within 90 days after the first date setfor the meeting of creditors. Fed. R. Bankr. P.3002(c). A governmental unit, however, has180 days from the date the case is filed file aproof of claim. 11 U.S.C. § 502(b)(9).

After the meeting of creditors, the debtor, thechapter 12 trustee, and interested creditorswill attend a hearing on confirmation of thedebtor’s chapter 12 repayment plan.

THE CHAPTER 12 PLAN ANDCONFIRMATION HEARING

Unless the court grants an extension, thedebtor must file a plan of repayment with thepetition or within 90 days after filing the

petition. 11 U.S.C. § 1221. The plan, whichmust be submitted to the court for approval,provides for payments of fixed amounts to thetrustee on a regular basis. The trustee thendistributes the funds to creditors according tothe terms of the plan, which typically offerscreditors less than full payment on theirclaims.

There are three types of claims: priority,secured, and unsecured. Priority claims arethose granted special status by the bankruptcylaw, such as most taxes and the costs ofbankruptcy proceeding.2 Secured claims arethose for which the creditor has the right toliquidate certain property if the debtor doesnot pay the underlying debt. In contrast tosecured claims, unsecured claims aregenerally those for which the creditor has nospecial rights to collect against particularproperty owned by the debtor.

A chapter 12 plan usually lasts three to fiveyears. It must provide for full payment of allpriority claims, unless a priority creditoragrees to different treatment of the claim or,in the case of a domestic support obligation,unless the debtor contributes all “disposableincome” - discussed below - to a five-yearplan. 11 U.S.C. § 1222(a)(2), (4).

Secured creditors must be paid at least asmuch as the value of the collateral pledged forthe debt. One of the features of Chapter 12 isthat payments to secured creditors cansometimes continue longer than the three-to-five-year period of the plan. For example, ifthe debtor’s underlying debt obligation wasscheduled to be paid over more than five years(i.e., an equipment loan or a mortgage), thedebtor may be able to pay the loan off overthe original loan repayment schedule as longas any arrearage is made up during the plan.

47The plan does not have to pay unsecuredclaims in full, as long as it commits all of thedebtor’s projected “disposable income” (orproperty of equivalent value) to planpayments over a 3 to 5 year period ,and aslong as the unsecured creditors are to receiveat least as much as they would receive if thedebtor’s nonexempt assets were liquidatedunder chapter 7. 11 U.S.C. § 1225.“Disposable income” is defined as income notreasonably necessary for the maintenance orsupport of the debtor or dependents or formaking payments needed to continue,preserve, and operate the debtor’s business. 11U.S.C. § 1225(b)(2).

Within 45 days after filing the plan, thepresiding bankruptcy judge decides at a“confirmation hearing” whether the plan isfeasible and meets the standards forconfirmation under the Bankruptcy Code. 11U.S.C. §§ 1224, 1225. Creditors, who receive21 days’ notice, may appear at the hearing andobject to confirmation. Fed. R. Bankr. P.2002(a)(8). While a variety of objections maybe made, the typical arguments are thatpayments offered under the plan are less thancreditors would receive if the debtor’s assetswere liquidated, or that the plan does notcommit all of the debtor’s disposable incomefor the three-to-five-year period of the plan.

If the court confirms the plan, the chapter 12trustee will distribute funds received inaccordance with the terms of the plan.11U.S.C. § 1226(a). If the court does notconfirm the plan, the debtor may file amodified plan. 11 U.S.C. § 1223. The debtormay also convert the case to a liquidationunder chapter 7.3 11 U.S.C. § 1208(a). If thedebtor fails to confirm a plan and the case isdismissed, the court may authorize the trusteeto keep some of the funds for costs, but thetrustee must return all remaining funds to the

debtor (other than funds already disbursed tocreditors). 11 U.S.C. § 1226(a).

On occasion, changed circumstances willaffect the debtor’s ability to make planpayments. A creditor may object or threaten toobject to a plan, or the debtor mayinadvertently have failed to list all creditors.In such instances, the plan may be modifiedeither before or after confirmation. 11 U.S.C.§§ 1223, 1229. Modification afterconfirmation is not limited to an initiative bythe debtor, but may also be made at therequest of the trustee or an unsecuredcreditor.11 U.S.C. § 1229(a).

MAKING THE PLAN WORK

The provisions of a confirmed plan bind thedebtor and each creditor. 11 U.S.C. § 1227.Once the court confirms the plan, the debtormust make the plan succeed. The debtor mustmake regular payments to the trustee, whichwill require adjustment to living on a fixedbudget for a prolonged period. Furthermore,while confirmation of the plan entitles thedebtor to retain property as long as paymentsare made, the debtor may not incur anysignificant new debt without consulting thetrustee, because additional debt maycompromise the debtor’s ability to completethe plan.11 U.S.C. §§ 1222(a)(1), 1227. Inany event, failure to make the plan paymentsmay result in dismissal of the case. 11 U.S.C.§ 1208(c). In addition, the court may dismissthe case or convert the case to a liquidationcase under chapter 7 of the Bankruptcy Codeupon a showing that the debtor has committedfraud in connection with the case. 11 U.S.C. § 1208(d).

48THE CHAPTER 12 DISCHARGE

The debtor will receive a discharge aftercompleting all payments under the chapter 12plan as long as the debtor certifies (ifapplicable) that all domestic supportobligations that came due before making suchcertification have been paid. The dischargehas the effect of releasing the debtor from alldebts provided for by the plan allowed undersection 503 or disallowed under section 502,with limited exceptions. Those creditors whowere provided for in full or in part under theplan may no longer initiate or continue anylegal or other action against the debtor tocollect the discharged obligations.

Certain categories of debts are not dischargedin chapter 12 proceedings. 11 U.S.C. § 1228(a). Those categories include debts foralimony and child support; money obtainedthrough filing false financial statements; debtsfor willful and malicious injury to person orproperty; debts for death or personal injurycaused by the debtor’s operation of a motorvehicle while the debtor was intoxicated; anddebts from fraud or defalcation while acting ina fiduciary capacity, embezzlement orlarceny. The bankruptcy law regarding thescope of a chapter 12 discharge is complex,however, and debtors should consultcompetent legal counsel in this regard prior tofiling. Those debts which will not bedischarged should be paid in full under a plan.With respect to secured obligations, thosedebts may be paid beyond the end of the planpayment period and, accordingly, are notdischarged.

CHAPTER 12 HARDSHIP DISCHARGE

The court may grant a “hardship discharge” toa chapter 12 debtor even though the debtor

has failed to complete plan payments. 11U.S.C. § 1228(b). Generally, a hardship discharge isavailable only to a debtor whose failure tocomplete plan payments is due tocircumstances beyond the debtor’s control andthrough no fault of the debtor. Creditors musthave received at least as much as they wouldhave received in a chapter 7 liquidation case,and the debtor must be unable to modify theplan. For example, injury or illness thatprecludes employment sufficient to fund evena modified plan may serve as the basis for ahardship discharge. The hardship dischargedoes not apply to any debts that arenondischargeable in a chapter 7 case. 11U.S.C. § 523.

NOTES

1. In North Carolina and Alabama, bankruptcyadministrators perform similar functions thatU.S. trustees perform in the remaining forty-eight states. The bankruptcy administratorprogram is administered by theAdministrative Office of the United StatesCourts, while the U.S. trustee program isadministered by the Department of Justice.For purposes of this publication, references toU.S. trustees are also applicable to bankruptcyadministrators.

2. Section 507 sets forth 10 categories ofunsecured claims which Congress has, forpublic policy reasons, given priority ofdistribution over other unsecured claims.

3. A fee of $15 is charged for converting acase under chapter 12 to a case under chapter7.

49

Chapter 9

Municipality Bankruptcy

The first municipal bankruptcy legislation wasenacted in 1934 during the Great Depression.Pub. L. No. 251, 48 Stat. 798 (1934). AlthoughCongress took care to draft the legislation so asnot to interfere with the sovereign powers of thestates guaranteed by the Tenth Amendment tothe Constitution, the Supreme Court held the1934 Act unconstitutional as an improperinterference with the sovereignty of the states.Ashton v. Cameron County Water ImprovementDist. No. 1, 298 U.S. 513, 532 (1936). Congressenacted a revised Municipal Bankruptcy Act in1937, Pub. L. No. 302, 50 Stat. 653 (1937),which was upheld by the Supreme Court.United States v. Bekins, 304 U.S. 27, 54 (1938).The law has been amended several times since1937. In the more than 60 years since Congressestablished a federal mechanism for theresolution of municipal debts, there have beenfewer than 500 municipal bankruptcy petitionsfiled. Although chapter 9 cases are rare, a filingby a large municipality can— like the 1994filing by Orange County, California—involvemany millions of dollars in municipal debt.

PURPOSE OF MUNICIPALBANKRUPTCY

The purpose of chapter 9 is to provide afinancially-distressed municipality protectionfrom its creditors while it develops andnegotiates a plan for adjusting its debts.Reorganization of the debts of a municipality istypically accomplished either by extending debtmaturities, reducing the amount of principal orinterest, or refinancing the debt by obtaining anew loan.

Although similar to other chapters in somerespects, chapter 9 is significantly differentin that there is no provision in the law forliquidation of the assets of the municipalityand distribution of the proceeds to creditors.Such a liquidation or dissolution wouldundoubtedly violate the Tenth Amendmentto the Constitution and the reservation to thestates of sovereignty over their internalaffairs. Indeed, due to the severe limitationsplaced upon the power of the bankruptcycourt in chapter 9 cases (required by theTenth Amendment and the Supreme Court’sdecisions in cases upholding municipalbankruptcy legislation), the bankruptcycourt generally is not as active in managinga municipal bankruptcy case as it is incorporate reorganizations under chapter 11.

The functions of the bankruptcy court inchapter 9 cases are generally limited toapproving the petition (if the debtor iseligible), confirming a plan of debtadjustment, and ensuring implementation ofthe plan. As a practical matter, however, themunicipality may consent to have the courtexercise jurisdiction in many of thetraditional areas of court oversight inbankruptcy, in order to obtain the protectionof court orders and eliminate the need formultiple forums to decide issues.

ELIGIBILITY

Only a “municipality” may file for reliefunder chapter 9. 11 U.S.C. § 109(c). Theterm “municipality” is defined in theBankruptcy Code as a “political subdivisionor public agency or instrumentality of aState.” 11 U.S.C. § 101(40). The definitionis broad enough to include cities, counties,townships, school districts, and publicimprovement districts. It also includesrevenue-producing bodies that provide

50services which are paid for by users rather thanby general taxes, such as bridge authorities,highway authorities, and gas authorities.

Section 109(c) of the Bankruptcy Codes setsforth four additional eligibility requirements forchapter 9:

1.The municipality must be specificallyauthorized to be a debtor by State law or bya governmental officer or organizationempowered by State law to authorize themunicipality to be a debtor;

2.The municipality must be insolvent, asdefined in 11 U.S.C. § 101(32)(C);

3.The municipality must desire to effect aplan to adjust its debts; and

4.The municipality must either:

• obtain the agreement of creditors holding atleast a majority in amount of the claims ofeach class that the debtor intends to impairunder a plan in a case under chapter 9;

• negotiate in good faith with creditors andfail to obtain the agreement of creditorsholding at least a majority in amount of theclaims of each class that the debtor intendsto impair under a plan;

• be unable to negotiate with creditorsbecause such negotiation is impracticable;or

• reasonably believe that a creditor mayattempt to obtain a preference.

COMMENCEMENT OF THE CASE

Municipalities must voluntarily seek protectionunder the Bankruptcy Code. 11 U.S.C. §§ 303,

901(a). They may file a petition only underchapter 9. A case under chapter 9concerning an unincorporated tax or specialassessment district that does not have itsown officials is commenced by the filing ofa voluntary “petition under this chapter bysuch district’s governing authority or theboard or body having authority to levy taxesor assessments to meet the obligations ofsuch district.” 11 U.S.C. § 921(a).

A municipal debtor must file a list ofcreditors. 11 U.S.C. § 924. Normally, thedebtor files the list of creditors with thepetition. However, the bankruptcy court hasdiscretion to fix a different time if the debtoris unable to prepare the list of creditors inthe form and with the detail required by theBankruptcy Rules at the time of filing. Fed.R. Bankr. P. 1007.

ASSIGNMENT OF CASE TO ABANKRUPTCY JUDGE

One significant difference between chapter9 cases and cases filed under other chaptersis that the clerk of court does notautomatically assign the case to a particularjudge. “The chief judge of the court ofappeals for the circuit embracing the districtin which the case is commenced[designates] the bankruptcy judge toconduct the case.” 11 U.S.C. § 921(b). Thisprovision was designed to remove politicsfrom the issue of which judge will presideover the chapter 9 case of a majormunicipality and to ensure that a municipalcase will be handled by a judge who has thetime and capability of doing so.

NOTICE OF CASE/OBJECTIONS/ ORDER FOR RELIEF

51The Bankruptcy Code requires that notice begiven of the commencement of the case and theorder for relief. 11 U.S.C. § 923. TheBankruptcy Rules provide that the clerk, or suchother person as the court may direct, is to givenotice. Fed. R. Bankr. P. 2002(f). The noticemust also be published “at least once a week forthree successive weeks in at least onenewspaper of general circulation publishedwithin the district in which the case iscommenced, and in such other newspaperhaving a general circulation among bond dealersand bondholders as the court designates.” 11U.S.C. § 923. The court typically enters anorder designating who is to give and receivenotice by mail and identifying the newspapersin which the additional notice is to be published.Fed. R. Bankr. P. 9007, 9008.

The Bankruptcy Code permits objections to thepetition. 11 U.S.C. § 921(c). Typically,objections concern issues like whethernegotiations have been conducted in good faith,whether the state has authorized themunicipality to file, and whether the petitionwas filed in good faith. If an objection to thepetition is filed, the court must hold a hearingon the objection. Id. The court may dismiss apetition if it determines that the debtor did notfile the petition in good faith or that the petitiondoes not meet the requirements of title 11. Id.

If the petition is not dismissed upon anobjection, the Bankruptcy Code requires thecourt to order relief, allowing the case toproceed under chapter 9. 11 U.S.C. § 921(d).

AUTOMATIC STAY

The automatic stay of section 362 of theBankruptcy Code is applicable in chapter 9cases. 11 U.S.C. §§ 362(a), 901(a). The stayoperates to stop all collection actions against thedebtor and its property upon the filing of the

petition. Additional automatic stayprovisions are applicable in chapter 9 thatprohibit actions against officers andinhabitants of the debtor if the action seeksto enforce a claim against the debtor. 11U.S.C. § 922(a). Thus, the stay prohibits acreditor from bringing a mandamus actionagainst an officer of a municipality onaccount of a prepetition debt. It alsoprohibits a creditor from bringing an actionagainst an inhabitant of the debtor toenforce a lien on or arising out of taxes orassessments owed to the debtor.

Section 922(d) of title 11 limits theapplicability of the stay. Under that section,a chapter 9 petition does not operate to stayapplication of pledged special revenues topayment of indebtedness secured by suchrevenues. Thus, an indenture trustee or otherpaying agent may apply pledged funds topayments coming due or distribute thepledged funds to bondholders withoutviolating the automatic stay.

PROOFS OF CLAIM

In a chapter 9 case, the court fixes the timewithin which proofs of claim or interest maybe filed. Fed. R. Bankr. P. 3003(c)(3). Manycreditors may not be required to file a proofof claim in a chapter 9 case. For example, aproof of claim is deemed filed if it appearson the list of creditors filed by the debtor,unless the debt is listed as disputed,contingent, or unliquidated. 11 U.S.C. § 925. Thus, a creditor must file a proof ofclaim if the creditor’s claim appears on thelist of creditors as disputed, contingent, orunliquidated.

COURT’S LIMITED POWER

52Sections 903 and 904 of the Bankruptcy Codeare designed to recognize the court’s limitedpower over operations of the debtor.

Section 904 limits the power of the bankruptcycourt to “interfere with – (1) any of the politicalor governmental powers of the debtor; (2) anyof the property or revenues of the debtor; or (3)the debtor’s use or enjoyment of any income-producing property” unless the debtor consentsor the plan so provides. The provision makes itclear that the debtor’s day-to-day activities arenot subject to court approval and that the debtormay borrow money without court authority. Inaddition, the court cannot appoint a trustee(except for limited purposes specified in 11U.S.C. § 926(a)) and cannot convert the case toa liquidation proceeding.

The court also cannot interfere with theoperations of the debtor or with the debtor’s useof its property and revenues. This is due, at leastin part, to the fact that in a chapter 9 case, thereis no property of the estate and thus no estate toadminister. 11 U.S.C. § 902(1). Moreover, achapter 9 debtor may employ professionalswithout court approval, and the only courtreview of fees is in the context of planconfirmation, when the court determines thereasonableness of the fees.

The restrictions imposed by 11 U.S.C. § 904are necessary to ensure the constitutionality ofchapter 9 and to avoid the possibility that thecourt might substitute its control over thepolitical or governmental affairs or property ofthe debtor for that of the state and the electedofficials of the municipality.

Similarly, 11 U.S.C. § 903 states that “chapter[9] does not limit or impair the power of a Stateto control, by legislation or otherwise, amunicipality of or in such State in the exerciseof the political or governmental powers of the

municipality, including expenditures forsuch exercise,” with two exceptions—a statelaw prescribing a method of composition ofmunicipal debt does not bind any non-consenting creditor, nor does any judgmententered under such state law bind anonconsenting creditor.

ROLE OF THE U.S.TRUSTEE/BANKRUPTCYADMINISTRATOR

In a chapter 9 case, the role of the U.S.trustee (or the bankruptcy administrator inNorth Carolina or Alabama)1 is typicallymore limited than in chapter 11 cases.Although the U.S. trustee appoints acreditors’ committee, the U.S. trustee doesnot examine the debtor at a meeting ofcreditors (there is no meeting of creditors),does not have the authority to move forappointment of a trustee or examiner or forconversion of the case, and does notsupervise the administration of the case.Further, the U.S. trustee does not monitorthe financial operations of the debtor orreview the fees of professionals retained inthe case.

ROLE OF CREDITORS

The role of creditors is more limited inchapter 9 than in other cases. There is nofirst meeting of creditors, and creditors maynot propose competing plans. If certainrequirements are met, the debtor’s plan isbinding on dissenting creditors. The chapter9 debtor has more freedom to operatewithout court-imposed restrictions.

In each chapter 9 case, however, there is acreditors’ committee that has powers andduties that are very similar to those of acommittee in a chapter 11 case. These

53powers and duties include selecting andauthorizing the employment of one or moreattorneys, accountants, or other agents torepresent the committee; consulting with thedebtor concerning administration of the case;investigating the acts, conduct, assets, liabilities,and financial condition of the debtor;participating in the formulation of a plan; andperforming such other services as are in theinterest of those represented. 11 U.S.C. §§ 901(a), 1103.

INTERVENTION/RIGHT OF OTHERSTO BE HEARD

When cities or counties file for relief underchapter 9, there may be a great deal of interestin the case from entities wanting to appear andbe heard. The Bankruptcy Rules provide that“[t]he Secretary of the Treasury of the UnitedStates may, or if requested by the court shall,intervene in a chapter 9 case.” Fed. R. Bankr. P.2018(c). Further, “[r]epresentatives of the statein which the debtor is located may intervene ina chapter 9 case.” Id. In addition, theBankruptcy Code permits the Securities andExchange Commission to appear and be heardon any issue and gives parties in interest theright to appear and be heard on any issue in acase. 11 U.S.C. §§ 901(a), 1109. Parties ininterest include municipal employees, localresidents, non-resident owners of real property,special tax payers, securities firms, and localbanks.

POWERS OF THE DEBTOR

Due to statutory limitations placed upon thepower of the court in a municipal debtadjustment proceeding, the court is far lessinvolved in the conduct of a municipalbankruptcy case (and in the operation of the

municipal entity) while the debtor’sfinancial affairs are undergoingreorganization. The municipal debtor hasbroad powers to use its property, raise taxes,and make expenditures as it sees fit. It isalso permitted to adjust burdensome non-debt contractual relationships under thepower to reject executory contracts andunexpired leases, subject to court approval,and it has the same avoiding powers as otherdebtors. Municipalities may also rejectcollective bargaining agreements and retireebenefit plans without going through theusual procedures required in chapter 11cases.

A municipality has authority to borrowmoney during a chapter 9 case as anadministrative expense. 11 U.S.C. §§ 364,901(a). This ability is important to thesurvival of a municipality that has exhaustedall other resources. A chapter 9 municipalityhas the same power to obtain credit as itdoes outside of bankruptcy. The court doesnot have supervisory authority over theamount of debt the municipality incurs in itsoperation. The municipality may employprofessionals without court approval, andthe professional fees incurred are reviewedonly within the context of planconfirmation.

DISMISSAL

As previously noted, the court may dismissa chapter 9 petition, after notice and ahearing, if it concludes the debtor did notfile the petition in good faith or if thepetition does not meet the requirements ofchapter 9. 11 U.S.C. § 921(c). The courtmay also dismiss the petition for cause, suchas for lack of prosecution, unreasonabledelay by the debtor that is prejudicial tocreditors, failure to propose or confirm a

54plan within the time fixed by the court, materialdefault by the debtor under a confirmed plan, ortermination of a confirmed plan by reason of theoccurrence of a condition specified in the plan.11 U.S.C. § 930.

TREATMENT OF BONDHOLDERS ANDOTHER LENDERS

Different types of bonds receive differenttreatment in municipal bankruptcy cases.General obligation bonds are treated as generaldebt in the chapter 9 case. The municipality isnot required to make payments of eitherprincipal or interest on account of such bondsduring the case. The obligations created bygeneral obligation bonds are subject tonegotiation and possible restructuring under theplan of adjustment.

Special revenue bonds, by contrast, willcontinue to be secured and serviced during thependency of the chapter 9 case throughcontinuing application and payment of ongoingspecial revenues. 11 U.S.C. § 928. Holders ofspecial revenue bonds can expect to receivepayment on such bonds during the chapter 9case if special revenues are available. Theapplication of pledged special revenues toindebtedness secured by such revenues is notstayed as long as the pledge is consistent with11 U.S.C. § 928 [§ 922(d) erroneously refers to§ 927 rather than § 928], which insures that alien of special revenues is subordinate to theoperating expenses of the project or systemfrom which the revenues are derived. 11 U.S.C.§ 922(d).

Bondholders generally do not have to worryabout the threat of preference liability withrespect to any prepetition payments on accountof bonds or notes, whether special revenue orgeneral obligations. Any transfer of themunicipal debtor’s property to a noteholder or

bondholder on account of a note or bondcannot be avoided as a preference, i.e., as anunauthorized payment to a creditor madewhile the debtor was insolvent. 11 U.S.C.§ 926(b).

PLAN FOR ADJUSTMENT OFDEBTS

The Bankruptcy Code provides that thedebtor must file a plan. 11 U.S.C. § 941.The plan must be filed with the petition or atsuch later time as the court fixes. There isno provision in chapter 9 allowing creditorsor other parties in interest to file a plan. Thislimitation is required by the SupremeCourt’s pronouncements in Ashton, 298U.S. at 528, and Bekins, 304 U.S. at 51,which interpreted the Tenth Amendment asrequiring that a municipality be left incontrol of its governmental affairs during achapter 9 case. Neither creditors nor thecourt may control the affairs of amunicipality indirectly through themechanism of proposing a plan ofadjustment of the municipality’s debts thatwould in effect determine the municipality’sfuture tax and spending decisions.

CONFIRMATION STANDARDS

The standards for plan confirmation inchapter 9 cases are a combination of thestatutory requirements of 11 U.S.C. §943(b) and those portions of 11 U.S.C. §1129 (the chapter 11 confirmationstandards) made applicable by 11 U.S.C.§ 901(a). Section 943(b) lists seven generalconditions required for confirmation of a

55plan. The court must confirm a plan if thefollowing conditions are met:

1. the plan complies with the provisions of title11 made applicable by sections 103(e) and 901;

2. the plan complies with the provisions ofchapter 9;

3. all amounts to be paid by the debtor or by anyperson for services or expenses in the case orincident to the plan have been fully disclosedand are reasonable;

4. the debtor is not prohibited by law fromtaking any action necessary to carry out theplan;

5. except to the extent that the holder of aparticular claim has agreed to a differenttreatment of such claim, the plan provides thaton the effective date of the plan, each holder ofa claim of a kind specified in section 507(a)(1)will receive on account of such claim cash equalto the allowed amount of such claim;

6. any regulatory or electoral approvalnecessary under applicable nonbankruptcy lawin order to carry out any provision of the planhas been obtained, or such provision isexpressly conditioned on such approval; and

7. the plan is in the best interests of creditorsand is feasible.

11 U.S.C. § 943(b).

Section 943(b)(1) requires as a condition forconfirmation that the plan comply with theprovisions of the Bankruptcy Code madeapplicable by sections 103(e) and 901(a) of theBankruptcy Code. The most important of thesefor purposes of confirming a plan are thoseprovisions of 11 U.S.C. § 1129 (i.e.,

§ 1129(a)(2), (a)(3), (a)(6), (a)(8), (a)(10))that are made applicable by 11 U.S.C. §901(a). Section 1129(a)(8) requires, as acondition to confirmation, that the plan hasbeen accepted by each class of claims orinterests impaired under the plan. Therefore,if the plan proposes treatment for a class ofcreditors such that the class is impaired (i.e.,the creditor’s legal, equitable, or contractualrights are altered), then that class’sacceptance is required. If the class is notimpaired, then acceptance by that class isnot required as a condition to confirmation.Under 11 U.S.C. § 1129(a)(10), the courtmay confirm the plan only if, should anyclass of claims be impaired under the plan,at least one impaired class has accepted theplan. If only one impaired class of creditorsconsents to the plan, plan confirmation isstill possible under the “cram down”provisions of 11 U.S.C. § 1129(b). Under“cram down,” if all other requirements aremet except the § 1129(a)(8) requirementthat all classes either be unimpaired or haveaccepted the plan, then the plan isconfirmable if it does not discriminateunfairly and is fair and equitable.

The requirement that the plan be in the “bestinterests of creditors” means somethingdifferent under chapter 9 than under chapter11. Under chapter 11, a plan is said to be inthe “best interest of creditors” if creditorswould receive as much under the plan asthey would if the debtor were liquidated. 11U.S.C. § 1129(a)(7)(A)(ii). Obviously, adifferent interpretation is needed in chapter9 cases because a municipality’s assetscannot be liquidated to pay creditors. In thechapter 9 context, the “best interests ofcreditors” test has generally been interpretedto mean that the plan must be better thanother alternatives available to the creditors.See 6 COLLIER ON BANKRUPTCY

56§ 943.03[7] (15th ed. rev. 2005). Generallyspeaking, the alternative to chapter 9 isdismissal of the case, permitting every creditorto fend for itself. An interpretation of the “ bestinterests of creditors” test to require that themunicipality devote all resources available tothe repayment of creditors would appear toexceed the standard. The courts generally applythe test to require a reasonable effort by themunicipal debtor that is a better alternative forits creditors than dismissal of the case. Id.

Parties in interest may object to confirmation,including creditors whose claims are affected bythe plan, an organization of employees of thedebtor, and other tax payers, as well as theSecurities and Exchange Commission. 11U.S.C. §§ 901(a), 943, 1109, 1128(b).

DISCHARGE

A municipal debtor receives a discharge in achapter 9 case after: (1) confirmation of theplan; (2) deposit by the debtor of anyconsideration to be distributed under the planwith the disbursing agent appointed by thecourt; and (3) a determination by the court thatsecurities deposited with the disbursing agentwill constitute valid legal obligations of thedebtor and that any provision made to pay orsecure payment of such obligations is valid. 11U.S.C. § 944(b). Thus, the discharge isconditioned not only upon confirmation, butalso upon deposit of the consideration to bedistributed under the plan and a courtdetermination of the validity of securities to beissued.

There are two exceptions to the discharge inchapter 9 cases. The first is for any debtexcepted from discharge by the plan or orderconfirming the plan. The second is for a debtowed to an entity that, before confirmation of

the plan, had neither notice nor actualknowledge of the case. 11 U.S.C. § 944(c).

At any time within 180 days after entry ofthe confirmation order, the court may, afternotice and a hearing, revoke the order ofconfirmation if the order was procured byfraud. 11 U.S.C. §§ 901(a), 1144.

NOTES

1. In North Carolina and Alabama,bankruptcy administrators perform similarfunctions that United States trustees performin the remaining forty-eight states. Thebankruptcy administrator program isadministered by the Administrative Officeof the United States Courts, while theUnited States trustee program isadministered by the Department of Justice.For purposes of this publication, referencesto United States trustees are also applicableto bankruptcy administrators.

57

Chapter 15

Ancillary and Other Cross-BorderCases

Chapter 15 is a new chapter added to theBankruptcy Code by the Bankruptcy AbusePrevention and Consumer Protection Act of2005. It is the U.S. domestic adoption of theModel Law on Cross-Border Insolvencypromulgated by the United Nations Commissionon International Trade Law (“UNCITRAL”) in1997, and it replaces section 304 of theBankruptcy Code. Because of the UNCITRALsource for chapter 15, the U.S. interpretationmust be coordinated with the interpretationgiven by other countries that have adopted it asinternal law to promote a uniform andcoordinated legal regime for cross-borderinsolvency cases.

The purpose of Chapter 15, and the Model Lawon which it is based, is to provide effectivemechanisms for dealing with insolvency casesinvolving debtors, assets, claimants and otherparties in interest involving more than onecountry. This general purpose is realizedthrough five objectives specified in the statute:(1) to promote cooperation between the UnitedStates courts and parties in interest and thecourts and other competent authorities offoreign countries involved in cross-borderinsolvency cases; (2) to establish greater legalcertainty for trade and investment; (3) toprovide for the fair and efficient administrationof cross-border insolvencies that protects theinterests of all creditors and other interestedentities, including the debtor; (4) to affordprotection and maximization of the value of thedebtor’s assets; and (5) to facilitate the rescue offinancially troubled businesses, therebyprotecting investment and preservingemployment. 11 U.S.C. § 1501.

Generally, a chapter 15 case is ancillary toa primary proceeding brought in anothercountry, typically the debtor’s homecountry. As an alternative, the debtor or acreditor may commence a full chapter 7 orchapter 11 case in the United States if theassets in the United States are sufficientlycomplex to merit a full-blown domesticbankruptcy case. 11 U.S.C. § 1520(c). Inaddition, under chapter 15 a U.S. court mayauthorize a trustee or other entity (includingan examiner) to act in a foreign country onbehalf of a U.S. bankruptcy estate. 11U.S.C. § 1505. An ancillary case is commenced underchapter 15 by a “foreign representative”filing a petition for recognition of a “foreignproceeding.”1 11 U.S.C. § 1504. Chapter 15gives the foreign representative the right ofdirect access to U.S. courts for this purpose.11 U.S.C. § 1509. The petition must beaccompanied by documents showing theexistence of the foreign proceeding and theappointment and authority of the foreignrepresentative. 11 U.S.C. § 1515. Afternotice and a hearing, the court is authorizedto issue an order recognizing the foreignproceeding as either a “foreign mainproceeding” (a proceeding pending in acountry where the debtor’s center of maininterests are located) or a “foreign non-mainproceeding” (a proceeding pending in acountry where the debtor has anestablishment,2 but not its center of maininterests). 11 U.S.C. § 1517. Immediatelyupon the recognition of a foreign mainproceeding, the automatic stay and selectedother provisions of the Bankruptcy Codetake effect within the United States. 11U.S.C. § 1520. The foreign representative isalso authorized to operate the debtor’sbusiness in the ordinary course. Id. The U.S.

58court is authorized to issue preliminary relief assoon as the petition for recognition is filed. 11U.S.C. § 1519.

Through the recognition process, chapter 15operates as the principal door of a foreignrepresentative to the federal and state courts ofthe United States. 11 U.S.C. § 1509. Oncerecognized, a foreign representative may seekadditional relief from the bankruptcy court orfrom other state and federal courts and isauthorized to bring a full (as opposed toancillary) bankruptcy case. 11 U.S.C. §§ 1509,1511. In addition, the representative isauthorized to participate as a party in interest ina pending U.S. insolvency case and to intervenein any other U.S. case where the debtor is aparty. 11 U.S.C. §§ 1512, 1524.

Chapter 15 also gives foreign creditors the rightto participate in U.S. bankruptcy cases and itprohibits discrimination against foreigncreditors (except certain foreign governmentand tax claims, which may be governed bytreaty). 11 U.S.C. § 1513. It also requires noticeto foreign creditors concerning a U.S.bankruptcy case, including notice of the right tofile claims. 11 U.S.C. § 1514.

One of the most important goals of chapter 15 isto promote cooperation and communicationbetween U.S. courts and parties in interest withforeign courts and parties in interest in cross-border cases. This goal is accomplished by,among other things, explicitly charging thecourt and estate representatives to “cooperate tothe maximum extent possible” with foreigncourts and foreign representatives andauthorizing direct communication between thecourt and authorized estate representatives andthe foreign courts and foreign representatives.11 U.S.C. §§ 1525 - 1527.

If a full bankruptcy case is initiated by aforeign representative (when there is aforeign main proceeding pending in anothercountry), bankruptcy court jurisdiction isgenerally limited to the debtor’s assets thatare located in the United States. 11 U.S.C. § 1528. The limitation promotescooperation with the foreign mainproceeding by limiting the assets subject toU.S. jurisdiction, so as not to interfere withthe foreign main proceeding. Chapter 15also provides rules to further cooperationwhere a case was filed under theBankruptcy Code prior to recognition of theforeign representative and for coordinationof more than on foreign proceeding. 11U.S.C. §§ 1529 - 1530.

The UNCITRAL Model Law has also beenadopted (with certain variations) in Canada,Mexico, Japan and several other countries.Adoption is pending in the United Kingdomand Australia, as well as other countrieswith significant international economicinterests.

NOTES

1. A “foreign proceeding” is a “judicial oradministrative proceeding in a foreigncountry ... under a law relating to insolvencyor adjustment of debt in which proceedingthe [debtor’s assets and affairs] are subjectto control or supervision by a foreign courtfor the purpose of reorganization orliquidation.” 11 U.S.C. § 101(23). A“foreign representative” is the person orentity authorized in the foreign proceeding“to administer the reorganization orliquidation of the debtor’s assets or affairsor to act as a representative of such foreignproceeding.”

592. An establishment is a place of operationswhere the debtor carries out a long termeconomic activity. 11 U.S.C. § 1502(2).

60

Servicemembers’ CivilRelief Act

BACKGROUND

The Servicemembers’ Civil Relief Act(“SCRA”) is found at 50 U.S.C. app. §§ 501 etseq. The purpose of the SCRA is strengthen andexpedite national defense by givingservicemembers certain protections in civilactions. By providing for the temporarysuspension of judicial and administrativeproceedings and transactions that may adverselyaffect servicemembers during their militaryservice, the SCRA enables servicemembers tofocus their energy on the defense of the UnitedStates. Among other things, the SCRA allowsfor forbearance and reduced interest on certainobligations incurred prior to military service,and it restricts default judgments againstservicemembers and rental evictions ofservicemembers and all their dependents. TheSCRA applies to all members of the UnitedStates military on active duty, and to U.S.citizens serving in the military of United Statesallies in the prosecution of a war or militaryaction. The provisions of the SCRA generallyend when a servicemember is discharged fromactive duty or within 90 days of discharge, orwhen the servicemember dies. Portions of theSCRA also apply to reservists and inducteeswho have received orders but not yet reported toactive duty or induction into the militaryservice.

GENERAL PROVISIONS

There are three primary areas of coverageunder the SCRA: (1) protection against theentry of default judgments; (2) stay ofproceedings where the servicemember hasnotice of the proceeding; and (3) stay or

vacation of execution of judgments,attachments and garnishments. 50 U.S.C.app. §§ 521, 522 and 524.

Protection Against Default Judgements

Section 521 of the SCRA establishes certainprocedures that must be followed in all civilproceedings in order to protectservicemember defendants against the entryof default judgements. These procedures areoutlined below:

•If a defendant is in default for failure toappear in the action filed by the plaintiff,the plaintiff must file an affidavit1 withthe court before a default judgment maybe entered. The affidavit must statewhether the defendant is in the military,or that the plaintiff was unable todetermine whether the defendant is in themilitary.

•If, based on the filed affidavits, thecourt cannot determine whether thedefendant is in the military, it maycondition entry of judgment against thedefendant upon the plaintiff’s filing of abond. The bond would indemnify thedefendant against any loss or damageincurred because of the judgment if thejudgment is later set aside in whole or inpart.

•The court may not order entry ofjudgment against the defendant if thedefendant is in the military until after thecourt appoints an attorney to representthe defendant.

•If requested by counsel for aservicemember defendant, or upon the

61court’s own motion, the court will grant astay of proceedings for no less than 90 daysif it determines that (1) there may be adefense and the defense cannot be presentedwithout the defendant’s presence; or (2)after due diligence the defendant’s attorneyhas not been able to contact the defendant orotherwise determine if a meritorious defenseexists.

•The court may, in its discretion, makefurther orders or enter further judgments toprotect the rights of the defendant under theSCRA.

•If a judgment is entered against thedefendant while he or she is in militaryservice or within 60 days of discharge frommilitary service, and the defendant wasprejudiced in making his or her defensebecause of his or her military service, thejudgment may, upon application by thedefendant, be opened by the court and thedefendant may then provide a defense.Before the judgment may be opened,however, the defendant must show that he orshe has a meritorious or legal defense tosome or all of the action.

Stay of Proceedings Where Servicemember HasNotice

Outside the default context, and at any timebefore final judgement in a civil action, a personcovered by the SCRA who has received noticeof a proceeding may ask the court to stay theproceeding. 50 U.S.C. app. § 522. The courtmay also order a stay on its own motion. Id. Thecourt will grant the servicemember’s stayapplication and will stay the proceeding for atleast 90 days if the application includes: (1) aletter or other communication setting forth facts

demonstrating that the individual’s currentmilitary duty requirements materially affectthe servicemember’s ability to appear alongwith a date when the servicemember will beable to appear; and (2) a letter or othercommunication from the servicemember’scommanding officer stating that theservicemember’s current military dutyprevents his or her appearance and thatmilitary leave is not authorized for theservicemember at the time of the letter. Thecourt has discretion to grant additional staysupon further application.

Stay or Vacation of Execution ofJudgements, Attachments and Garnishments

In addition to the court’s ability to regulatedefault judgments and stay proceedings, thecourt may on its own motion and must uponapplication: (1) stay the execution of anyjudgment or order entered against aservicemember; and (2) vacate or stay anyattachment or garnishment of theservicemember’s property or assets, whetherbefore or after judgment if it finds that theservicemember’s ability to comply with thejudgment or garnishment is materiallyaffected by military service. 50 U.S.C. app.§ 524. The stay of execution may be orderedfor any part of the servicemember’s militaryservice plus 90 days after discharge fromthe service. The court may also order theservicemember to make installmentpayments during any stay ordered.

Additional Protections

Several additional rights are available underthe SCRA. For example, when an action forcompliance with a contract is stayed underthe SCRA, contractual penalties do notaccrue during the period of the stay. 50U.S.C. app. § 523. The SCRA also provides

62in most instances that a landlord cannot evict aservicemember or dependants from a primaryresidence without a court order. In an evictionproceeding, the court may also adjust the leaseobligations to protect the interests of the parties.50 U.S.C. app. § 531. If the court stay theeviction proceeding, it may provide equitablerelief to the landlord by ordering garnishment ofa portion of the servicemember’s pay. Id. Underthe SCRA a servicemember may terminateresidential and automotive leases if he or she istransferred after the lease is made. 50 U.S.C.app. § 535. A court may also extend some of theprotections afforded a servicemember under theSCRA to persons co-liable or secondarily liableon the servicemember’s obligation. 50 U.S.C.app. § 513.

APPLICABILITY TO BANKRUPTCYPROCEEDINGS

The language of the SCRA states that it isgenerally applicable in any action or proceedingcommenced in any court. 50 U.S.C. app. §§521, 522 and 524. Therefore, absentcontravening language with respect tobankruptcy proceedings, the SCRA applies toall actions or proceedings before a bankruptcycourt.

The applicability of the SCRA in bankruptcyproceedings is also evident in the Federal Rulesof Civil Procedure and the Federal Rules ofBankruptcy Procedure. For example, theadvisory committee note to Federal Rule fordefault judgments, Fed. R. Civ. P. 55(b), statesthat it is directly affected by the SCRA.2 UnderFed. R. Bankr. P. 7055 and 9014 of the FederalRules of Bankruptcy Procedure, Fed. R. Civ. P.55 is applicable in bankruptcy adversaryproceedings and contested matters. Thus, thedefault judgment protections of the SCRAclearly apply in bankruptcy cases.

The bankruptcy court clerk’s office is awareof the requirement that the plaintiff mustprovide an affidavit stating whether thedefendant is in the military before defaultmay be entered against the defendant.Bankruptcy Procedural Forms B260,B261A, and B261B, and theiraccompanying instructions, provideadditional guidance concerning theapplicability of the SCRA to defaultjudgments and related proceduralrequirements.

NOTES

1. The requirement for an affidavit may besatisfied by a statement, declaration,verification, or certificate in writingsubscribed and certified or declared to betrue under penalty of perjury. 50 U.S.C. app.§ 521(4).

2. The advisory committee note to Fed. R.Civ. P. 55 comments on the applicability ofthe Servicemembers’ Civil Relief Act(formally known as the Soldiers’ andSailors’ Civil Relief Act of 1940) to defaultjudgements as follows:

The operation of Rule 55(b) (Judgment) isdirectly affected by the Soldiers’ andSailors’ Civil Relief Act of 1940, 50 U.S.C.Appendix, § 501 et seq. Section 200 of theAct [50 U.S.C. Appendix, § 520] imposesspecific requirements which must befulfilled before a default judgment can beentered, e.g., Ledwith v. Storkan,D.Neb.1942, 6 Fed. Rules Serv. 60b.24,Case 2, 2 F.R.D. 539, and also provides forthe vacation of a judgment in certaincircumstances. See discussion inCommentary, Effect of ConscriptionLegislation on the Federal Rules, 1940, 3

63Fed. Rules Serv. 725; 3 Moore’s FederalPractice, 1938, Cum. Supplement § 55.02.

64

Securities InvestorProtection Act

OVERVIEW

Typically, when a brokerage firm fails, theSecurities Investor Protection Corporation(“SIPC”) arranges the transfer of the failedbrokerage’s accounts to a different securitiesbrokerage firm. If the SIPC is unable to arrangethe accounts’ transfer, the failed firm isliquidated. In that case, the SIPC sendsinvestors either certificates for the stock thatwas lost or a check for the market value of theshares.

Although the Bankruptcy Code provides for astockbroker liquidation proceeding, 11 U.S.C. § 741 et seq., it is far more likely that a failingbrokerage will find itself involved in aproceeding under the Securities InvestorProtection Act of 1970 (“SIPA”) (15 U.S.C. §§ 78aaa et seq.), rather than a BankruptcyCode liquidation case. Brokerage firms may beliquidated under the Bankruptcy Code,however, if the SIPC does not file anapplication for a protective decree with thedistrict court or if the district court finds thatcustomers of the brokerage firm are not in needof protection under the SIPA. 15 U.S.C.§§ 78eee.

HISTORY

Before 1938, little protection existed forcustomers of a bankrupt stockbroker unless theycould trace cash and securities held by failedstockbrokers. In 1938 Congress enacted section60(e) of the Bankruptcy Act creating a singleand separate fund concept to minimize losses tocustomers by giving them priority over claimsof general creditors. 1898 Bankruptcy Act

§ 60(e)(2) (repealed). Because the fund wasnormally inadequate, however, customerlosses continued.

Following a period of great expansion in thesecurities industry during the 1960's, aserious business contraction hit the industryin 1969-1970. This situation led tovoluntary l iquidat ions, mergers ,receiverships, and bankruptcies of asubstantial number of brokerage houses.Annotation, Validity, Construction, andApplication of Securities InvestorProtection Act of 1970, 23 A.L.R. Fed. 157,179 (1975). The cash and securitiescustomers that had deposited with thesefailed firms were dissipated or tied up inlengthy bankruptcy proceedings. In additionto mounting customer losses and thesubsequent erosion of investor confidence,the Congress was concerned with a possible“domino effect” involving otherwise solventbrokers that had substantial opentransactions with firms that failed.

Congress enacted the SIPA in reaction tothis growing concern. The goal was toprevent the failure of more brokeragehouses, restore investor confidence in thecapital markets, and upgrade the financialresponsibility requirements for registeredbrokers and dealers. Securities InvestorProtection Corp. v. Barbour, 421 U.S. 412,414 (1975). Congress designed the SIPA toapportion responsibility for carrying out thevarious goals of the legislation to severalgroups. Among them are the Securities andExchange Commission (hereinafter referredto as SEC), various securities industry self-regulatory organizations, and the SIPC. TheSIPA was designed to create a new form ofliquidation proceeding. It is applicable onlyto member firms and was designed toaccomplish the completion of open

65transactions and the speedy return of mostcustomer property. Id.

SIPA

The SIPA is codified in Title 15 of the UnitedStates Code at Sections 78aaa - 111. The SIPAcreated the SIPC, a nonprofit, privatemembership corporation to which mostregistered brokers and dealers are required tobelong. 15 U.S.C. § 78ccc. The SIPC fund,which constitutes an insurance program, isauthorized under 15 U.S.C. § 78ddd(a), andassessments against members are authorized by15 U.S.C. §§ 78ddd(c) and (d). The fund isdesigned to protect the customers of brokers ordealers subject to the SIPA from loss in case offinancial failure of the member. The fund issupported by assessments upon its members. Ifthe fund should become inadequate, the SIPAauthorizes borrowing against the U.S. Treasury.An analogy could be made to the role of theFederal Deposit Insurance Corporation in thebanking industry. BANKRUPTCY LIQUIDATION VERSUSTHE SIPA LIQUIDATION INBANKRUPTCY COURT

The essential difference between a liquidationunder the Bankruptcy Code and one under theSIPA is that under the Bankruptcy Code thetrustee is charged with converting securities tocash as quickly as possible and, with theexception of the delivery of customer namesecurities, making cash distributions tocustomers of the debtor in satisfaction of theirclaims. A SIPC trustee, on the other hand, isrequired to distribute securities to customers tothe greatest extent practicable in satisfaction oftheir claims against the debtor. There is a fundamental difference in orientationbetween the two proceedings. There is a

statutory grant of authority to a SIPC trusteeto purchase securities to satisfy customer netequity claims to specified securities. 15U.S.C. §78fff-2(d). The trustee is requiredto return customer name securities tocustomers of the debtor (15 U.S.C. § 78fff-2(c)(2)), distribute the fund of “customerproperty” ratably to customers (15 U.S.C.§ 78fff-2(b)), and pay, with money from theSIPC fund, remaining customer net equityclaims, to the extent provided by the Act(15 U.S.C. §§ 78fff-2(b) and 3(a)). A trusteeoperating under the Bankruptcy Code lackssimilar resources. The Code seeks to protectthe filing date value of a customer’ssecurities account by liquidating all non-customer name securities. SIPA seeks topreserve an investor’s portfolio as it stoodon the filing date. Under SIPA, the customerwill receive securities whenever possible.

ROLE OF THE DISTRICT COURT

15 U.S.C. § 78eee(a)(3)(A) provides that theSIPC may file an application for aprotective decree with the U.S. district courtif the SIPC determines that any member hasfailed or is in danger of failing to meetobligations to customers and meets one ofthe four conditions specified in 15 U.S.C.§ 78eee(b)(1). This application is filed as acivil case in which the SIPC or the SEC orboth are named as plaintiff, and the membersecurities firm is named as the debtor-defendant. In the event that the SIPC refusesto act under the SIPA, the SEC may apply tothe U.S. District Court for the District ofColumbia to require the SIPC to dischargeits obligations under the SIPA. 15 U.S.C.§ 78ggg(b). By contrast, customers offailing broker-dealers do not have animplied right of action under the SIPA tocompel the SIPC to exercise its statutoryauthority for their benefit. Barbour,421 U.S.

66at 425. Upon the filing of an application, thedistrict court has exclusive jurisdiction of thedebtor-defendant and its property.

The institution of a case under the SIPA bringsa pending bankruptcy liquidation to a halt.Irrespective of the automatic stay, the SIPC mayfile an application for a protective decree underSIPA. 11 U.S.C. § 742; 15 U.S.C. § 78aaa etseq. The filing stays all proceedings in thebankruptcy case until the SIPC action iscompleted. Id. Pending issuance of a protectivedecree, the district court:

[i.] shall stay any pending bankruptcy,mor tgage forec losure , equi tyreceivership, or other proceeding toreorganize, conserve, or liquidate thedebtor or its property and any other suitagainst any receiver, conservator, ortrustee of the debtor or its property, andshall continue such stay uponappointment of a trustee ...

[ii.] may stay any proceeding to enforcea lien against property of the debtor orany other suit against the debtor,including a suit by stockholders of thedebtor which interferes with prosecutionby the trustee of claims against formerdirectors, officers, or employees of thedebtor, and may continue such stay uponappointment of a trustee ...

[iii.] may stay enforcement of, and uponappointment of a trustee ... [if aprotective decree is issued] ... maycontinue the stay for such period of timeas may be appropriate, but shall notabrogate any right of setoff, except to theextent such right may be affected undersection 553 of Title 11, ... and shall notabrogate the right to enforce a valid,

nonpreferential lien or pledge againstthe property of the debtor; and

[iv.] may appoint a temporaryreceiver.

15 U.S.C. § 78eee(b)(2)(B)(I - iv) (emphasisadded).

In addition, upon the filing of a SIPCapplication, 11 U.S.C. § 362 comes intoeffect.

The SIPA provides that the district courtwill issue a protective decree if the debtorconsents, the debtor fails to contest theapplication for a protective decree, or thedistrict court finds that one of the conditionsspecified in 15 U.S.C. § 78eee(b)(1) exist. Ifthe court issues a protective decree, then thecourt will appoint a trustee and an attorneyfor the trustee whom the SIPC, in its solediscretion, specifies. 15 U.S.C.§ 78eee(b)(3). Upon the issuance of aprotective decree and appointment of atrustee, or a trustee and counsel, the districtcourt will order the removal of the entireliquidation proceeding to the bankruptcycourt in the same judicial district. 15 U.S.C.§ 78eee(b)(4).

REMOVAL TO BANKRUPTCYCOURT

The case is removed to the bankruptcy courtas an adversary proceeding for liquidation.No filing or removal fee is charged. Thereason for using an adversary proceedingnumber is historical. Although the SIPAproceedings are not bankruptcy cases, bylaw certain procedures prescribed inchapters 1, 3, and 5, and subchapters I and IIof chapter 7 of Title 11 of the U.S. Code areapplicable in SIPA proceedings. In addition,

67there is no related bankruptcy case number.Statistical reports to the Administrative Officeshould repeat the adversary number so that theStatistics Division will know it is a SIPAmatter. Forms B111A (Adversary ProceedingOpening Report) and B111B (AdversaryProceeding Closing Report) should be usedsince this is an adversary proceeding. Foradversary proceedings within the adversarySIPA proceeding, the clerk’s office should usethe original adversary proceeding number forthe related case number.

The SIPA requires that the bankruptcy courthold a hearing with 10 days notice to customers,creditors, and stockholders on thedisinterestedness of the trustee or attorney forthe trustee. 15 U.S.C. § 78eee(b)(6)(B). At thehearing, the court will entertain grounds forobjection to the retention of the trustee orattorney for the trustee including, among otherthings, insider considerations. 15 U.S.C.§ 78eee(b)(6)(A). If SIPC appoints itself astrustee, it should be deemed disinterested, andwhere a SIPC employee has been specified, theemployee can not be disqualified solely becauseof his employment. Id. Neither the BankruptcyCode, Bankruptcy Rules, nor SIPA provide forU.S. trustee or bankruptcy administratorinvolvement.

The SIPA provides for noticing of bothcustomers and creditors. The noticingrequirements provided for in 15 U.S.C. § 78fff-2(a)(1) are performed by the trustee, not theclerk of the bankruptcy court. While the SIPAdoes not require a formal proof of claim forcustomers (other than certain insiders and theirrelatives), it does require a written statement ofclaim. The trustee will normally providecustomers with claim forms and instructions.The claim form must be filed with the trusteerather than the clerk of the bankruptcy court. 15U.S.C. § 78fff-2(a)(2). With limited, specified

exceptions, no claim of a customer or othercreditor can be allowed unless it is receivedby the trustee within six months after theinitial publication of notice. 15 U.S.C. §78fff-2(a)(3).

LIQUIDATION PROCEEDINGS

The purposes of a SIPA liquidation are: (1)to deliver customer name securities to or onbehalf of customers; (2) to distributecustomer property and otherwise satisfy netequity claims of customers; (3) to sell ortransfer offices and other productive units ofthe debtor’s business; (4) to enforce therights of subrogation; and (5) to liquidatethe business as promptly as possible. 15U.S.C. § 78fff(a). To the extent possible,consistent with SIPA, the liquidation isconducted in accordance with chapters 1, 3,5 and subchapters I and II of chapter 7 ofTitle 11. 15 U.S.C. § 78fff(b). A section 341meeting of creditors is conducted by thetrustee. Noncustomer claims are handled asin an asset case. Costs and expenses, andpriorities of distribution from the estate, areallowed as provided in section 726 of Title11. Funds advanced by SIPC to the trusteefor costs and expenses are recouped fromthe estate, to the extent there is any estate.11 U.S.C. § 507.

POWERS OF THE TRUSTEE

The powers of the trustee in a SIPC case areessentially the same as those vested in achapter 7 trustee appointed under Title 11.“In addition, a trustee may, with theapproval of SIPC but without any need forcourt approval:

(1) hire and fix the compensation of allpersonnel (including officers andemployees of the debtor and of its

68examining authority) and other persons(including accountants) that are deemed bythe trustee necessary for all or any purposesof the liquidation proceeding;

(2) utilize SIPC employees for all or anypurposes of a liquidation proceeding; and

(3) margin and maintain customer accountsof the debtor . . .”

15 U.S.C. § 78fff-1(a).

A SIPC trustee may reduce to money customersecurities constituting customer property or inthe general estate of the debtor. 15 U.S.C.§ 78fff-1(b). The trustee must, however, deliversecurities to customers to the maximum extentpracticable. 15 U.S.C. § 78fff-1(b)(1). Subjectto prior approval of SIPC, but again without anyneed for court approval, the trustee may alsopay or guarantee any part of the debtor’sindebtedness to a bank, person, or other lenderwhen certain conditions exist. 15 U.S.C. § 78fff-1(b)(2).

The trustee is responsible for investigating theacts, conduct, and condition of the debtor andreporting thereon to the court. 15 U.S.C.§ 78fff-1(d)(1). The trustee must also provide astatement on the investigation to SIPC and toother persons as the court might direct. 15U.S.C. § 78fff-1(d)(4). Moreover, the trusteemust make periodic reports to the court and toSIPC on the progress of distribution of cash andsecurities to customers. 15 U.S.C. § 78fff-1(c).

CLAIMS

Upon receipt of a written statement of claim, thetrustee promptly discharges obligations of thedebtor relating to cash and securities bydelivering securities or making payments to oron behalf of the customer insofar as such

obligations are ascertainable from booksand records of the debtor, or are otherwiseestablished to the satisfaction of the trustee.The value of securities delivered in thisregard are calculated as of the close ofbusiness on the filing date. 15 U.S.C.§ 78fff-2(b).

The court must authorize the trustee tosatisfy claims out of monies advanced bySIPC for this purpose, notwithstanding thatthe estate may not have sufficient funds forsuch payment. 15 U.S.C. § 78fff-2(b)(1).The court is generally not involved in theprocess except to the extent that a disputearises between the trustee and customersregarding specific claims. Simple objectionsstay with the initial adversary proceeding.Occasionally, however, significant litigationarises in this area which generates relatedactions in the form of additional adversaryproceedings.

DISTRIBUTION

Customer related property of the debtor isallocated in the following order:

1. To SIPC in repayment of advancesmade to the extent they were used torecover securities apportioned tocustomer property;

2. To customers of the debtor on thebasis of their net equities;3. To SIPC as subrogee for the claims ofcustomers; and

4. To SIPC in repayment of advancesmade by SIPC to transfer or sellcustomer accounts to another SIPCmember firm.

6915 U.S.C. § 78fff-2(c)(1).

The trustee must deliver customer namesecurities to the customer if the customer is notindebted to the debtor. If indebted, the customermay, with the approval of the trustee, reclaimsecurities in his or her name upon payment tothe trustee of all such indebtedness. 15 U.S.C. § 78fff-2(c)(2).

The trustee may, with the approval of the SIPC,sell or otherwise transfer to another member ofthe SIPC, without consent of any customer, allor any part of the account of a customer.15 U.S.C. § 78fff-2(f). The trustee may alsoenter into any agreement, and the SIPC willadvance funds as necessary, to indemnify themember firm against shortages of cash orsecurities in customer accounts sold ortransferred. 15 U.S.C. § 78fff-2(f)(2). Inaddition, the trustee may purchase securities ina fair and orderly market in order to deliversecurities to customers in satisfaction of theirclaims. 15 U.S.C. § 78fff-2(d).

To the extent customer property and the SIPCadvances are not sufficient to pay or satisfy infull the net equity claims of customers, thencustomers are entitled to participate in the estateas unsecured creditors. 15 U.S.C. § 78fff-2(c)(1).

ADVANCES

The law requires that SIPC make advances tothe trustee in order to satisfy claims andotherwise liquidate the business. Theseadvances are made to satisfy customer claims incash, to purchase securities to satisfy net equityclaims in lieu of cash, and to pay all necessarycosts and expenses of administration andliquidation of the estate to the extent the estateof the debtor is insufficient to pay said costs andexpenses. Any amount advanced in satisfaction

of customer claims may not exceed$500,000 per customer. 15 U.S.C. § 78fff-3(a). If part of the claim is for cash, the totalamount advanced for cash payment must notexceed $100,000. 15 U.S.C. § 78fff-3(a)(1).The difference between cash payments andthe maximum amount allowed can besatisfied by the delivery of securities, orcash in lieu of securities.

DIRECT PAYMENT UNDER SIPAOUTSIDE THE BANKRUPTCYCOURT

In certain situations, the SIPC may elect toutilize a direct payment procedure to thecustomers of a debtor, thereby avoiding atrustee and the courts. Certain preconditionsmust exist. The claims of all customers mustaggregate less than $250,000, the debtormust be financially distressed as defined inthe law, and the cost to the SIPC for directpayment process must be less than forliquidation through the courts. 15 U.S.C. § 78fff-4(a).

If direct payment is utilized, the entireproceeding remains outside the court. Theprocess remains essentially a transactionbetween the SIPC and the debtor’scustomers.

Although the SIPA provides for a directpayment procedure in lieu of instituting aliquidation proceeding, the bankruptcy courtmay still become involved in disputesregarding the direct payment procedure. Aperson aggrieved by a SIPC determinationwith respect to a claim in a direct paymentprocedure may, within six months followingmailing of a SIPC determination, seek afinal adjudication of such claim by thecourt. 15 U.S.C. § 78fff-4(e). The courtshaving jurisdiction over cases under Title 11

70have original and exclusive jurisdiction of anycivil action for the adjudication of such claims.The action is to be brought in the judicialdistrict where the head office of the debtor islocated. It would be brought as an adversaryproceeding in the bankruptcy court even thoughthere is no main case.

ROLE OF SECURITIES ANDEXCHANGE COMMISSION

The SEC is responsible for regulating andsupervising the activities of the SIPC. The SECpromulgates operating rules that establish therole of self-regulatory organizations andexamining authorities, and their reportingresponsibilities to the SIPC of inspections andreviews of its member firms. The SIPC’smember firms are also required to provideinformation and documentation as necessary toassist in accomplishing these inspections. Thepenalties for fraud, deceit, or withholding ofinformation throughout the processes coveredby this law are severe. 15 U.S.C. § 78jjj(c). COMPENSATION IN A SIPA ACTION

The SIPA specifies that the bankruptcy courtmust grant reasonable compensation for theservices and expenses of the trustee and theattorney for the trustee. Interim allowances arealso permitted. 15 U.S.C. § 78eee(b)(5)(A). Anyperson seeking allowances must file anapplication complying in form and content withprovisions in Title 11, and must also serve acopy on the debtor, SIPC, creditors and otherpersons the court may designate. The court isrequired to fix a time for a hearing on theapplication. Notice need not be given tocustomers whose claims have been or will bepaid in full or creditors who cannot reasonablybe expected to receive any distribution. 15U.S.C. § 78eee(b)(5)(B).

The SIPC will review the application andfile its recommendation with respect to suchallowances prior to the hearing on theapplication. In any case where theallowances are to be paid by SIPC withoutreasonable expectation of recoupment andthere is no difference between the amountapplied for and the amount recommendedby SIPC, the bankruptcy court must awardthat amount. 15 U.S.C. § 78eee(b)(5)(C). Ifthere is a difference, the court must, amongother considerations, place considerablereliance on the recommendation of SIPC. Ifthe estate is insufficient to cover theseawards as costs of administration, 15 U.S.C.§ 78eee(b)(5)(E) provides that SIPC willadvance the necessary funds to cover thecosts.

71

Bankruptcy Terminology

Most debtors who file a bankruptcy petition,and many of their creditors, know very littleabout the bankruptcy process. BankruptcyBasics is designed to provide debtors, creditors,judiciary employees, and the general publicwith a basic explanation of bankruptcy and howit works. This glossary of bankruptcyterminology explains, in layman’s terms, manyof the legal terms that are used in cases filedunder the Bankruptcy Code.

adversary proceeding A lawsuit arising in orrelated to a bankruptcy case that is commencedby filing a complaint with the court. Anonexclusive list of adversary proceedings is setforth in Fed. R. Bankr. P. 7001.

assume An agreement to continue performingduties under a contract or lease.

automatic stay An injunction thatautomatically stops lawsuits, foreclosures,garnishments, and all collection activity againstthe debtor the moment a bankruptcy petition isfiled.

bankruptcy A legal procedure for dealing withdebt problems of individuals and businesses;specifically, a case filed under one of thechapters of title 11 of the United States Code(the Bankruptcy Code).

bankruptcy administrator An officer of thejudiciary serving in the judicial districts ofAlabama and North Carolina who, like the U.S.trustee, is responsible for supervising theadministration of bankruptcy cases, estates, andtrustees; monitoring plans and disclosurestatements; monitoring creditors’ committees;monitoring fee applications; and performingother statutory duties. Compare U.S. trustee.

Bankruptcy Code The informal name fortitle 11 of the United States Code (11 U.S.C.§§ 101-1330), the federal bankruptcy law.

bankruptcy court The bankruptcy judgesin regular active service in each federaljudicial district; a unit of the district court.

bankruptcy estate All legal or equitableinterests of the debtor in property at the timeof the bankruptcy filing. (The estateincludes all property in which the debtor hasan interest, even if it is owned or held byanother person.)

bankruptcy judge A judicial officer of theUnited States district court who is the courtofficial with decision-making power overfederal bankruptcy cases.

bankruptcy petition The document filed bythe debtor (in a voluntary case) or bycreditors (in an involuntary case) by whichopens the bankruptcy case. (There areofficial forms for bankruptcy petitions.)

chapter 7 The chapter of the BankruptcyCode providing for “liquidation” (i.e., thesale of a debtor’s nonexempt property andthe distribution of the proceeds to creditors).

chapter 9 The chapter of the BankruptcyCode providing for reorganization ofmunicipalities (which includes cities andtowns, as well as villages, counties, taxingdistricts, municipal utilities, and schooldistricts).

chapter 11 The chapter of the BankruptcyCode providing (generally) forreorganization, usually involving acorporation or partnership. (A chapter 11debtor usually proposes a plan of

72reorganization to keep its business alive and paycreditors over time. People in business orindividuals can also seek relief in chapter 11.)

chapter 12 The chapter of the Bankruptcy Codeproviding for adjustment of debts of a “familyfarmer,” or a “family fisherman” as those termsare defined in the Bankruptcy Code.

chapter 13 The chapter of the Bankruptcy Codeproviding for adjustment of debts of anindividual with regular income. (Chapter 13allows a debtor to keep property and pay debtsover time, usually three to five years.)

chapter 15 The chapter of the BankruptcyCode dealing with cases of cross-borderinsolvency.

claim A creditor’s assertion of a right topayment from the debtor or the debtor’sproperty.

confirmation Bankruptcy judges’s approval ofa plan of reorganization or liquidation in chapter11, or payment plan in chapter 12 or 13.

consumer debtor A debtor whose debts areprimarily consumer debts.

consumer debts Debts incurred for personal,as opposed to business, needs.

contested matter Those matters, other thanobjections to claims, that are disputed but arenot within the definition of adversaryproceeding contained in Rule 7001.

contingent claim A claim that may be owed bythe debtor under certain circumstances, e.g.,where the debtor is a cosigner on anotherperson’s loan and that person fails to pay.

creditor One to whom the debtor owesmoney or who claims to be owed money bythe debtor.

credit counseling Generally refers to twoevents in individual bankruptcy cases: (1)the “individual or group briefing” from anonprofit budget and credit counselingagency that individual debtors must attendprior to filing under any chapter of theBankruptcy Code; and (2) the “instructionalcourse in personal financial management” inchapters 7 and 13 that an individual debtormust complete before a discharge is entered.There are exceptions to both requirementsfor certain categories of debtors, exigentcircumstances, or if the U.S. trustee orbankruptcy administrator have determinedthat there are insufficient approved creditcounseling agencies available to provide thenecessary counseling.

creditors’ meeting see 341 meeting

current monthly income The averagemonthly income received by the debtor overthe six calendar months beforecommencement of the bankruptcy case,including regular contributions to householdexpenses from nondebtors and income fromthe debtor’s spouse if the petition is a jointpetition, but not including social securityincome and certain other payments madebecause the debtor is the victim of certaincrimes. 11 U.S.C. § 101(10A).

debtor A person who has filed a petition forrelief under the Bankruptcy Code.

debtor education see credit counseling

defendant An individual (or business)against whom a lawsuit is filed.

73discharge A release of a debtor from personalliability for certain dischargeable debts set forthin the Bankruptcy Code. (A discharge releasesa debtor from personal liability for certain debtsknown as dischargeable debts and prevents thecreditors owed those debts from taking anyaction against the debtor to collect the debts.The discharge also prohibits creditors fromcommunicating with the debtor regarding thedebt, including telephone calls, letters, andpersonal contact.)

dischargeable debt A debt for which theBankruptcy Code allows the debtor’s personalliability to be eliminated.

disclosure statement A written documentprepared by a chapter 11 debtor or other planproponent designed to provide “adequateinformation” to creditors to enable them toevaluate the chapter 11 plan of reorganization.

equity The value of a debtor’s interest inproperty that remains after liens and othercreditors’ interests are considered. (Example: Ifa house valued at $100,000 is subject to a$80,000 mortgage, there is $20,000 of equity.)

executory contract or lease Generally includescontracts or leases under which both parties tothe agreement have duties remaining to beperformed. (If a contract or lease is executory,a debtor may assume it or reject it.)

exemptions, exempt property Certain propertyowned by an individual debtor that theBankruptcy Code or applicable state lawpermits the debtor to keep from unsecuredcreditors. For example, in some states the debtormay be able to exempt all or a portion of theequity in the debtor’s primary residence(homestead exemption), or some or all “tools ofthe trade” used by the debtor to make a living(i.e., auto tools for an auto mechanic or dental

tools for a dentist). The availability andamount of property the debtor may exemptdepends on the state the debtor lives in.

family farmer or family fisherman Anindividual, individual and spouse,corporation, or partnership engaged in afarming or fishing operation that meetscertain debt limits and other statutorycriteria for filing a petition under chapter 12.

fraudulent transfer A transfer of a debtor’sproperty made with intent to defraud or forwhich the debtor receives less than thetransferred property’s value.

fresh start The characterization of adebtor’s status after bankruptcy, i.e., free ofmost debts. (Giving debtors a fresh start isone purpose of the Bankruptcy Code.)

insider (of an individual debtor) Anyrelative of the debtor or of a general partnerof the debtor; partnership in which thedebtor is a general partner; general partnerof the debtor; or a corporation of which thedebtor is a director, officer, or person incontrol.

insider (of a corporate debtor) A director,officer, or person in control of the debtor; apartnership in which the debtor is a generalpartner; a general partner of the debtor; or arelative of a general partner, director,officer, or person in control of the debtor.

joint administration A court-approvedmechanism under which two or more casescan be administered together. (Assuming noconflicts of interest, these separatebusinesses or individuals can pool theirresources, hire the same professionals, etc.)

74joint petition One bankruptcy petition filed bya husband and wife together.

lien The right to take and hold or sell theproperty of a debtor as security or payment fora debt or duty.

liquidation A sale of a debtor’s property withthe proceeds to be used for the benefit ofcreditors. liquidated claim A creditor’s claim for a fixedamount of money.

means test Section 707(b)(2) of the BankruptcyCode applies a “means test” to determinewhether an individual debtor’s chapter 7 filingis presumed to be an abuse of the BankruptcyCode requiring dismissal or conversion of thecase (generally to chapter 13). Abuse ispresumed if the debtor’s aggregate currentmonthly income (see definition above) over 5years, net of certain statutorily allowedexpenses is more than (i) $10,950, or (ii) 25%of the debtor’s nonpriority unsecured debt, aslong as that amount is at least $6,575. Thedebtor may rebut a presumption of abuse onlyby a showing of special circumstances thatjustify additional expenses or adjustments ofcurrent monthly income.

motion to lift the automatic stay A request bya creditor to allow the creditor to take actionagainst the debtor or the debtor’s property thatwould otherwise be prohibited by the automaticstay.

no-asset case A chapter 7 case where there areno assets available to satisfy any portion of thecreditors’ unsecured claims.

nondischargeable debt A debt that cannot beeliminated in bankruptcy. Examples include a

home mortgage, debts for alimony or childsupport, certain taxes, debts for mostgovernment funded or guaranteededucational loans or benefit overpayments,debts arising from death or personal injurycaused by driving while intoxicated or underthe influence of drugs, and debts forrestitution or a criminal fine included in asentence on the debtor’s conviction of acrime. Some debts, such as debts for moneyor property obtained by false pretenses anddebts for fraud or defalcation while acting ina fiduciary capacity may be declarednondischargeable only if a creditor timelyfiles and prevails in a nondischargeabilityaction.

objection to dischargeability A trustee’s orcreditor’s objection to the debtor beingreleased from personal liability for certaindischargeable debts. Common reasonsinclude allegations that the debt to bedischarged was incurred by false pretensesor that debt arose because of the debtor’sfraud while acting as a fiduciary.

objection to exemptions A trustee’s orcreditor’s objection to the debtor’s attemptto claim certain property as exempt fromliquidation by the trustee to creditors.

party in interest A party who has standingto be heard by the court in a matter to bedecided in the bankruptcy case. The debtor,the U.S. trustee or bankruptcy administrator,the case trustee and creditors are parties ininterest for most matters.

petition preparer A business notauthorized to practice law that preparesbankruptcy petitions.

75plan A debtor’s detailed description of how thedebtor proposes to pay creditors’ claims over afixed period of time.

plaintiff A person or business that files a formalcomplaint with the court.

postpetition transfer A transfer of the debtor’sproperty made after the commencement of thecase.

prebankruptcy planning The arrangement (orrearrangement) of a debtor’s property to allowthe debtor to take maximum advantage ofexemptions. (Prebankruptcy planning typicallyincludes converting nonexempt assets intoexempt assets.)

preference or preferential debt payment Adebt payment made to a creditor in the 90-dayperiod before a debtor files bankruptcy (orwithin one year if the creditor was an insider)that gives the creditor more than the creditorwould receive in the debtor’s chapter 7 case.

presumption of abuse see means test

priority The Bankruptcy Code’s statutoryranking of unsecured claims that determines theorder in which unsecured claims will be paid ifthere is not enough money to pay all unsecuredclaims in full. For example, under theBankruptcy Code’s priority scheme, moneyowed to the case trustee or for prepetitionalimony and/or child support must be paid infull before any general unsecured debt (i.e. tradedebt or credit card debt) is paid.

priority claim An unsecured claim that isentitled to be paid ahead of other unsecuredclaims that are not entitled to priority status.Priority refers to the order in which theseunsecured claims are to be paid.

proof of claim A written statement andverifying documentation filed by a creditorthat describes the reason the debtor owes thecreditor money. (There is an official formfor this purpose.)

property of the estate All legal or equitableinterests of the debtor in property as of thecommencement of the case.

reaffirmation agreement An agreement bya chapter 7 debtor to continue paying adischargeable debt (such as an auto loan)after the bankruptcy, usually for the purposeof keeping collateral (i.e. the car) that wouldotherwise be subject to repossession.

secured creditor A creditor holding a claimagainst the debtor who has the right to takeand hold or sell certain property of thedebtor in satisfaction of some or all of theclaim.

secured debt Debt backed by a mortgage,pledge of collateral, or other lien; debt forwhich the creditor has the right to pursuespecific pledged property upon default.Examples include home mortgages, autoloans and tax liens.

schedules Detailed lists filed by the debtoralong with (or shortly after filing) thepetition showing the debtor’s assets,liabilities, and other financial information.(There are official forms a debtor must use.)

small business case A special type ofchapter 11 case in which there is nocreditors’ committee (or the creditors’committee is deemed inactive by the court)and in which the debtor is subject to moreoversight by the U.S. trustee than otherchapter 11 debtors. The Bankruptcy Code

76contains certain provisions designed to reducethe time a small business debtor is inbankruptcy.

statement of financial affairs A series ofquestions the debtor must answer in writingconcerning sources of income, transfers ofproperty, lawsuits by creditors, etc. (There is anofficial form a debtor must use.)

statement of intention A declaration made bya chapter 7 debtor concerning plans for dealingwith consumer debts that are secured byproperty of the estate.

substantive consolidation Putting the assetsand liabilities of two or more related debtorsinto a single pool to pay creditors. (Courts arereluctant to allow substantive consolidationsince the action must not only justify the benefitthat one set of creditors receives, but also theharm that other creditors suffer as a result.)

341 meeting The meeting of creditors requiredby section 341 of the Bankruptcy Code at whichthe debtor is questioned under oath by creditors,a trustee, examiner, or the U.S. trustee abouthis/her financial affairs. Also called creditors’meeting

transfer Any mode or means by which a debtordisposes of or parts with the debtor’s property.

trustee The representative of the bankruptcyestate who exercises statutory powers,principally for the benefit of the unsecuredcreditors, under the general supervision of thecourt and the direct supervision of the U.S.trustee or bankruptcy administrator. The trusteeis a private individual or corporation appointedin all chapter 7, chapter 12, and chapter 13 casesand some chapter 11 cases. The trustee’sresponsibilities include reviewing the debtor’s

petition and schedules and bringing actionsagainst creditors or the debtor to recoverproperty of the bankruptcy estate. In chapter7, the trustee liquidates property of theestate, and makes distributions to creditors.Trustees in chapter 12 and 13 have similarduties to a chapter 7 trustee and theadditional responsibilities of overseeing thedebtor’s plan, receiving payments fromdebtors, and disbursing plan payments tocreditors.

U.S. trustee An officer of the JusticeDepartment responsible for supervising theadministration of bankruptcy cases, estates,and trustees; monitoring plans anddisclosure statements; monitoring creditors’committees; monitoring fee applications;and performing other statutory duties.Compare, bankruptcy administrator.

undersecured claim A debt secured byproperty that is worth less than the fullamount of the debt.

unliquidated claim A claim for which aspecific value has not been determined.

unscheduled debt A debt that should havebeen listed by the debtor in the schedulesfiled with the court but was not. (Dependingon the circumstances, an unscheduled debtmay or may not be discharged.)

unsecured claim A claim or debt for whicha creditor holds no special assurance ofpayment, such as a mortgage or lien; a debtfor which credit was extended based solelyupon the creditor’s assessment of thedebtor’s future ability to pay.

voluntary transfer A transfer of a debtor’sproperty with the debtor’s consent.