Chapters In Bankruptcy: A Short Primer

A Short Primer on Chapters In Bankruptcy

RE: CHAPTER 7, 11, & 13 BANKRUPTCIES

This article is intended to provide background information on, and will discuss three chapters of the United States Bankruptcy Code – Chapter 7 (“liquidation” or “discharge” bankruptcy); Chapter 11 (“reorganization” bankruptcy); and, Chapter 13 (“wage-earner” bankruptcy).

Chapter 7 Bankruptcy:

Chapter 7 of the United States Bankruptcy Code provides for the sale of a debtor’s nonexempt property with the proceeds of sale being distributed among the debtor’s creditors. The process is called, “liquidation”. Chapter 7 bankruptcy is also known as “discharge bankruptcy”.

Chapter 7 relief may be available to individuals, partnerships, corporations, or other types of business entities. In a Chapter 7 bankruptcy proceeding, there are two types of cases – an “asset case” or a “no asset case”. A “no asset” case is one where all of the debtor’s assets are exempt and/or subject to valid creditor liens. An “asset case” is one where there is available nonexempt debtor property that is subject to being sold or “liquidated” to satisfy creditors’ claims. The majority of Chapter 7 cases end up being “no asset” cases.

In a Chapter 7 bankruptcy, the Bankruptcy Court exercises its authority over bankruptcy filers by a court-appointed outside official known as a “bankruptcy trustee”. While a bankruptcy trustee has several duties, the primary duty is to take measures to attempt a meaningful distribution of monies to the debtor’s unsecured creditors..

Once a Chapter 7 petition is filed with the bankruptcy court, an “automatic stay” goes into effect, immediately halting further collection efforts by most creditors..The stay prevents most creditors from legally garnishing wages, seizing bank accounts, or seizing other assets such as an automobile or a home.

Bankruptcy “exemptions” play an important role in a Chapter 7 proceeding by helping the trustee determine which property a debtor may retain. Some states, debtors are required to use the state’s exemptions, some States use the federal exemption and others give the option of using either the state’s exemptions or the federal exemptions.

Fully-exempt non-bankruptcy federal exemptions include: retirement benefits (civil, foreign, or military service retirees, railroad workers, CIA employees, veterans, Social Security recipients, and Military Medal of Honor awardees); death and disability benefits (longshoreman, harbor worker, or government employee, and compensation for risk, hazard, injury, or death resulting from war); survivors’ benefits (lighthouse workers, certain judiciary employees, and those in military service).

Additional, miscellaneous non-bankruptcy exemptions include:

  • Debts incurred by a seaman while on a voyage and seaman’s clothing
  • Military group life insurance proceeds
  • Indian lands
  • Homestead sale or lease proceeds
  • Railroad worker unemployment benefits
  • Military service member savings deposits (while on permanent duty outside of the U.S.)

A bankruptcy court may deny Chapter 7 bankruptcy discharge for several reasons, including a debtor’s failure to follow bankruptcy’s rules, procedures or an Order of the bankruptcy court. In Chapter 7 cases, debtors do not have automatic or absolute rights to discharge of debts. A creditor, a bankruptcy trustee, or the U.S. Trustee can object to the complete Chapter 7 discharge if a debtor fails to comply with certain rules or bankruptcy procedures, or fails to provide necessary and required information. Among the reasons that a Chapter 7 bankruptcy court may deny discharge are the following when the debtor:

  • Fails to complete required documents, forms, etc.
  • Defrauds or hinders creditors by transferring or hiding property or assets
  • Hides or destroys books, records, and other methods of accounting
  • Fails to provide tax documents
  • Commits perjury or other fraudulent acts in conjunction with the bankruptcy case
  • Fails to account for lost assets
  • Violates a court order
  • Previously filed a bankruptcy case within a certain time frame

There are several alternatives to Chapter 7 relief under the Bankruptcy Code. Debtors engaged in business as a corporation, partnership or sole proprietorship (and in certain cases, individuals) who prefer to remain in business and avoid liquidation may file a petition under Chapter 11. Under this chapter, debtors may seek a debt adjustment or an extension of time to repay certain debts. In many cases, such debtors may opt for a more comprehensive reorganization plan under Chapter 11.

Individual debtors may choose to file under Chapter 13 to seek an adjustment of debts. One advantage for individual debtors under Chapter 13 is it gives them the opportunity to save their primary residence from foreclosure by making “catch up” payments under a Chapter 13 payment plan.

Chapter 11 Bankruptcy:

A case filed under Chapter 11 of the United States Bankruptcy Code is frequently referred to as a “reorganization” bankruptcy. Chapter 11 bankruptcy is a form of bankruptcy whereby a corporation – or, an individual who has too much debt or income to qualify to file under Chapters 13 – opts for the reorganization of its debts through bankruptcy while, in many instances, continuing the normal operations of the affected enterprise during the bankruptcy proceedings.

A Chapter 11 bankruptcy case is initiated with the filing of a Petition. There are two types of petitions: a voluntary petition is filed by the debtor; an involuntary petition is filed by creditors of the debtor.

In Chapter 11 bankruptcy proceedings (the U.S. Trustee monitors the progress of the case and supervises its administration), the debtor remains in possession of the corporation or other business entity and continues to operate it under the supervision of the Trustee (or bankruptcy administrator) during the pendency of a case. Under provisions of the Bankruptcy Code, the debtor in possession is in the position of a fiduciary with rights and powers of a Chapter 11 Trustee – a debtor in possession is charged with performing all but the investigative functions and duties of a Trustee.

After filing a Chapter 11 petition, the debtor usually has an exclusive right for four months to propose a comprehensive reorganization plan. Under certain circumstances, and for good cause, the bankruptcy court can extend the debtor’s period of “exclusivity” for a maximum of eighteen months after the filing.

Upon the expiration of the exclusive period, the creditors’ committee or other parties in interest can file alternate or competing reorganization plans. The purpose of a “reorganization” is the restructuring of a debtor’s financial affairs.

Recent reports and studies show that between ten and fifteen percent of Chapter 11 cases actually result in successful reorganizations with positive results. Of those cases that fall within the 85 to 90% unsuccessful category, most cases are dismissed – often by agreement between the debtor and creditors – or converted to Chapter 7 liquidation cases. In either case (dismissal or conversion), the bankruptcy court must approve to validate the action. A bankruptcy court can, on its own initiative, dismiss or convert a Chapter 11 case “for cause” – such as when a debtor cannot show that it can successfully reorganize.

Chapter 13 Bankruptcy:

Chapter 13 of the Bankruptcy Code is geared toward individual debtors who have a regular income and need a reorganization plan that allows the debtor to keep property and pay debts over a period of usually three to five years. Chapter 13 bankruptcy is called a “wage earner’s plan” because it allows individuals with a regular income – usually from employment –to set up a plan to repay all or part of their debts.

The most significant advantage of a Chapter13 filing is that it allows individuals to stop a foreclosure on a primary residence. Delinquent payments can be “cured” over time under a Chapter 13 proceeding but the debtor must make all regular recurring mortgage payments as usual and on time. Chapter 13 also allows individual debtors to reschedule secured debts (other than debt on a primary residence) and extend them out over the life of the plan – this rescheduling of debt usually lowers the payment. Co-signers on consumer debt are also afforded special protections under Chapter 13 provisions.

As with a Chapter 7 case, the filing of a Chapter 13 petition is followed by the appointment of an impartial trustee to oversee and administer the case. The duties of the Chapter 13 trustee include the evaluation of a debtor’s case and serving as a disbursement officer by collecting payments from the debtor and distributing those to creditors. Another similarity with a Chapter 7 filing is the provision of the “automatic stay” at the commencement of the proceedings whereby creditor collection efforts against a debtor and the debtor’s property are stopped. Likewise, co-signers on consumer debt are also protected by the bankruptcy code in Chapter 13 proceedings, similar to the Chapter 7 rule.

While the requirements of Chapters 7 and 11 are quite stringent, those of Chapter 13 are even more so. The timelines in Chapter 13 provide an example:

  • Within thirty days of the plan’s filing, the debtor must start making payments to the trustee (even if the plan has not yet been formally approved by the bankruptcy court)
  • With secured debt (home mortgage or auto payment), a debtor must make adequate “protection payments” directly to the lender/creditor when payments are due before plan approval, taking into account with appropriate credit-back such direct pre-payments when payments to the trustee are begun
  • Confirmation hearing in the bankruptcy court must be held within forty-five days after the creditors’ meeting; determination is made as to whether or not the plan is feasible and meets the standards and requirements set for plan confirmation by the bankruptcy code
  • Creditors are given twenty-eight days advance notice of the confirmation hearing and have the right to object (typical objections may include that plan payments are less than what creditor would receive in liquidation proceedings or the plan does not account for use of all of debtor’s projected disposable income over the life of the plan, typically 3 to 5 years

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