Articles on Bankruptcy & Insolvency Issues

US Bankruptcy Basics Chapter, 7, 11 & 13BASICS OF US BANKRUPTCY CODE | Chapter 7, Chapter 11 & Chapter 13 

Bankruptcy Code is the informal name given for title 11 of the United States Code (11 U.S.C. §§ 101-1330), which is the federal bankruptcy law.

Under the Bankruptcy Code 'Bankruptcy' is a legal procedure for dealing with debt problems of individuals and businesses. It is specifically, a case filed under one of the chapters of title 11 of the United States Code informally called the Bankruptcy Code.

Bankruptcy helps individuals who are unable to pay their debts get a fresh start by liquidating assets to pay off their debts or by proposing a repayment plan. Bankruptcy law also gives protection to financially troubled businesses.

LIQUIDATION

Chapter 7

Chapter 7 of the Bankruptcy Code provides for 'Liquidation'. Liquidation involves the sale of an insolvent debtor's nonexempt property and the distribution of the proceeds to the creditors/lenders.

Individuals and Businesses may file bankruptcy under Chapter 7 to liquidate.

A chapter 7 claim commences when the debtor files a 'Petition' with the bankruptcy court that serves the jurisdiction where the individual debtor lives or where the business debtor is organized or has its principal place of business or principal assets. In addition to the petition, the debtor has to also file with the courts amongst other documents their record of assets and liabilities; table of current income and expenditures; a statement of financial affairs; a list of all creditors and the amount and nature of their claims; list of all of the debtor's property; and a schedule of executory contracts and unexpired leases. Individual debtors have to additionally file a certificate of credit counseling and a copy of any debt repayment plan developed during credit counseling and a detailed list of their monthly living expenses.

Filing a petition under chapter 7 stops (i.e. automatic stay) almost all collection actions against the debtor or the debtor's property. The automatic stay arises by operation of law and requires no additional judicial action. The bankruptcy clerk gives notice of the bankruptcy case to all creditors whose names and addresses are provided by the debtor. The filing the petition does not stay certain types of actions listed under 11 U.S.C. § 362(b), and the stay may be effective only for a short time in some situations.  As long as the stay is in effect, creditors generally may not initiate or continue lawsuits, wage garnishments, or even make collection telephone calls demanding payment.

When Chapter 7 petition gets filed, the U.S. trustee or the bankruptcy court appoints an impartial 'Case Trustee' to administer the case and liquidate the debtor's nonexempt assets. Between 21 and 40 days after the chapter 7 petition is filed by the debtor, the Case Trustee that is handling the case will hold a meeting of creditors. It is mandatory for the debtor to attend the meeting of creditors and answer any questions related to the debtor's financial affairs and property. The debtor must cooperate with the trustee and to provide any financial records or documents that the trustee wants. Bankruptcy judges do not attend the meeting of creditors.

Initiation of Chapter 7 bankruptcy case creates an "estate". The estate technically becomes the temporary legal owner of all the debtor's property and the debtor's creditors are paid from nonexempt property of this estate.

If the debtors has assets then the case is deemed to be an 'asset case' otherwise the case is declared 'no asset' case. In asset cases, the unsecured creditors must file their claims with the court within 90 days after the first date is set for the meeting of creditors.

In an asset case the role of a chapter 7 trustee is to liquidate/sell-off the debtor's free and clear of liens nonexempt assets and to  maximize returns to the debtor's unsecured creditors. The trustee also has additional powers to: set aside preferential payments made to creditors within 90 days before the filing of the petition; the trustee can also undo security interests and other prepetition transfers of property that were not properly perfected at the time of the petition. The trustee can also take action against fraudulent conveyance and bulk transfer. In some cases, for a business that has filed for chapter 7, the bankruptcy court may authorize the trustee to run a business if such activity helps in maximizing returns for its creditors.

Claims are paid in order of priority. Under 726, there are six classes of claims and each class must be paid in full before the next class is paid. The debtor is only paid if all other classes of claims have been fully paid and the case is closed after all assets of the debtor have been fully rendered by the case trustee.

In a chapter 7 case that involves an individual debtor, the primary goals of the individual debtor is to retain exempt property and receive a discharge that covers as many debts as possible. A discharge releases individual debtors from personal liability for most debts and prevents the unsecured creditors from taking action to collect from the discharged debtor. Secured creditors may retain some rights to seize property even after such a discharge is granted.

There are certain debts that are not discharged. Some of them are as follows: alimony and child support; certain taxes; certain educational loans etc.

Unsecured debts are loosely defined as debts for which the extension of credit to the debtor was made purely upon an credit assessment by the creditor of the debtor's ability to pay whereas secured debts are debts for which the loan or credit was extended based upon the debtor's ability to pay and additionally the creditor securing and registering the rights to seize the collateral assigned by the debtor if the debtor defaults.

There are also provisions for converting a case from chapter 7 to a chapter 11 case. It can be done upon a request received from the debtor.

REORGANIZATION

Chapter 11

Chapter 11 of the Bankruptcy Code provides for 'Reorganization' for businesses i.e. generally for a corporation or partnership. The purpose is to keep the business going by proposing a plan of reorganization  and paying off its creditors over a given period of time. People in business or individuals can also seek relief to reorganize their debts under chapter 11.

A chapter 11 case begins with the filing of a petition with the bankruptcy court within the jurisdiction where the debtor has a domicile or residence.

The petition can be voluntary or in voluntary. The petition when filed by the debtor is called voluntary petition. The petition when filed by the creditors against a debtor when given conditions are met is called an involuntary petition. Individual debtors have to additionally file a certificate of credit counseling and a copy of any debt repayment plan developed during credit counseling and a detailed list of their monthly living expenses.

A stay of creditor actions against the chapter 11 debtor automatically goes into effect when the bankruptcy petition is filed. 11 U.S.C. § 362(a). This automatic stay provides a relief period for the debtor, a period of time during which all collection activities, judgments, foreclosures and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition.

Debtor in Possession:  Upon filing a voluntary petition under chapter 11, the debtor automatically assumes the status as the "debtor in possession." 11 U.S.C. § 1101. So termed since the debtor keeps possession and control of its assets while undergoing a reorganization under chapter 11, without the appointment of a case trustee like in the case when a petition gets filed under chapter 7 (liquidation).

The debtor remains a Debtor in Possession until either the debtor's plan of reorganization is confirmed or the debtor's case is dismissed or the case gets converted to chapter 7 (liquidation). In few cases election of a trustee occurs and a chapter 11 trustee may get appointed. Mostly, the debtor under chapter 11 with assumes the identity of a Debtor in Possession and then as 'debtor in possession', runs the business and performs the many functions of a chapter 11 trustee U.S.C. § 1107(a).

The debtor (unless a "small business debtor") has a 120-day period during which the debtor has an exclusive right to file a plan. 11 U.S.C. § 1121(b). This exclusivity period may be extended or reduced by the court. But in no event may the exclusivity period, including all extensions, be longer than 18 months. 11 U.S.C. § 1121(d). After the exclusivity period has expired, a creditor or the case trustee may file a competing plan.

A chapter 11 case may continue for many years unless the court, the U.S. trustee, the committee, or another party in interest acts to ensure the case's timely resolution. The creditors' right to file a competing plan provides incentive for the debtor to file a plan within the exclusivity period and acts as a check on excessive delay in the case. Also, delays in formulating, filing, and obtaining confirmation of a plan often can prompt creditors to file motions for relief from stay, to convert the case to chapter 7 (liquidation), or to dismiss the case altogether.

The U.S. trustee plays a key role in monitoring; supervising operation of the business the administration and progress of a chapter 11 case. The U.S. trustee is responsible for the submission of operating reports of the business and fees.  Should a debtor in possession fail to comply with the reporting requirements, or fail to take the appropriate steps to bring the case to confirmation, the U.S. trustee may file a motion with the bankruptcy court to have the debtor's chapter 11 case converted to another chapter of the Bankruptcy Code or have the case dismissed.

Creditors' Committees: A creditor's committee is appointed by the U.S. trustee and consists of unsecured creditors who hold the seven largest unsecured claims against the debtor. This committees can play a major role and can act as an important security to the proper management of the business by the debtor in possession. Among other things, the committee can consult with the debtor in possession on administration of the case; it can investigate the debtor's conduct; it can monitor the day-to-day operation of the business that is run by the debtor in possession; and can participates in formulation of the reorganization plan. 11 U.S.C. § 1103. With the court's approval, the committee can hire an legal counsel or other professionals that may help in the performance of the duties of the creditor's committee.

Claims: The Bankruptcy Code defines a claim as: (1) a right to payment; (2) or a right to an equitable remedy for a failure of performance if the breach gives rise to a right to payment. 11 U.S.C. § 101(5).

Claims are listed by the debtor on the debtor's schedules. If any creditor whose claim is not scheduled  or is scheduled as disputed, contingent, or unliquidated must file a Proof of Claim by attaching evidence that provides proof for the claim.  All creditors with a valid claims are treated as a creditors for purposes of voting on the plan and distribution under it. Filing a proof of claim is not necessary if the creditor's claim is scheduled (but is not listed as disputed, contingent, or unliquidated by the debtor) because the debtor's schedules are deemed to constitute evidence of the validity and 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 any scheduling of that claim by the debtor. It is the responsibility of the creditor to determine whether the claim is accurately listed on the debtor's schedules. The debtor must provide notification to those creditors whose names are added and whose claims are listed as a result of an amendment to the schedules. The notification also should advise such creditors of their right to file proofs of claim and that their failure to do so may prevent them from voting upon the debtor's plan of reorganization or participating in any distribution under that plan. When a debtor amends the schedule of liabilities to add a creditor or change the status of any claims to disputed, contingent, or unliquidated, the debtor must provide notice of the amendment to any entity affected.

In a chapter 11 plan the debtor must designate classes of claims and interests for treatment under the reorganization. Generally, a plan will classify claim holders as secured creditors, unsecured creditors entitled to priority, general unsecured creditors, and equity security holders.

Under section 1126(c) of the Bankruptcy Code, an entire class of claims is deemed to accept a plan if the plan is accepted by creditors that hold at least two-thirds in amount and more than one-half in number of the allowed claims in the class. Under section 1129(a)(10), if there are impaired classes of claims (i.e., claims that are not going to be paid completely or in which some legal, equitable, or contractual right is altered), the court cannot confirm a plan unless it has been accepted by at least one class of non-insiders who hold impaired claims. Moreover, under section 1126(f), holders of unimpaired claims are deemed to have accepted the plan.

In order to confirm the plan, the court must find, among other things, that: (1) the plan is feasible; (2) it is proposed in good faith; and (3) the plan and the proponent of the plan are in compliance with the Bankruptcy Code. In order to satisfy the feasibility requirement, the court must find that confirmation of the plan is not likely to be followed by liquidation. Confirmation of a plan discharges a debtor from any debt that arose before the date of confirmation. After the plan is confirmed, the debtor is required to make plan payments and is bound by the provisions of the plan of reorganization. The confirmed plan creates new contractual rights, replacing or superseding pre-bankruptcy contracts.

REORGANIZATION

Chapter 13

Also called a wage earner's plan, Chapter 13 of the Bankruptcy Code provides for adjustment of debts of an individual that has a regular income. It allows a debtor to keep property and pay debts over time period of generally three to five years. During this period the law forbids creditors from starting or continuing collection efforts against the individual debtor.

Any individual, even if self-employed or operating an unincorporated business, is eligible for chapter 13 relief as long as the individual's unsecured debts are less than $394,725 and secured debts are less than $1,184,200. 11 U.S.C. § 109(e). A chapter 13 case begins with the filing of a petition with the bankruptcy court within the jurisdiction where the debtor has a domicile or residence.

Individual debtors have to additionally file a certificate of credit counseling and a copy of any debt repayment plan developed during credit counseling and a detailed list of their monthly living expenses.

When an individual files a chapter 13 petition, an impartial trustee is appointed to administer the case. 11 U.S.C. § 1302. The chapter 13 trustee evaluates the case and also serves as a disbursing agent that collects payments from the debtor and makes distributions to the creditors. 11 U.S.C. § 1302(b). The debtor must file a repayment plan with the petition or within 14 days after the petition is filed. A plan must be submitted for court approval and must provide for payments of fixed amounts to the trustee on a regular basis, typically biweekly or monthly. The trustee then distributes the funds to creditors according to the terms of the plan, which may offer creditors less than full payment on their claims.

Filing the petition under chapter 13 "automatically stays" (stops) most collection actions against the debtor or the debtor's property. 11 U.S.C. § 362. Between 21 and 50 days after the debtor files the chapter 13 petition, the chapter 13 trustee will hold a meeting of creditors. During this meeting, the trustee places the debtor under oath, and both the trustee and creditors may ask questions. The debtor must attend the meeting and answer questions regarding his or her financial affairs and the proposed terms of the plan.11 U.S.C. § 343. In a chapter 13 case, to participate in distributions from the bankruptcy estate, unsecured creditors must file their claims with the court within 90 days after the first date set for the meeting of creditors.

There are three types of claims: Priority, Secured, and Unsecured. Priority claims are those granted special status by the bankruptcy law, such as most taxes and the costs of bankruptcy proceeding. Secured claims are those for which the creditor has the right take back certain property/collateral if the debtor defaults on payment. Unsecured claims are generally those for which the creditor has no special rights to collect against particular property owned by the debtor.

In the reorganization plan priority claims must be paid in full. If the debtor wants to keep the collateral securing a particular claim, the plan must provide that the holder of the secured creditor(s) receive at least the value of the collateral or pay the full debt (in case there is depreciation involved).

The plan need not pay unsecured claims in full as long it provides that the debtor will pay all projected "disposable income" over an "applicable commitment period," and as long as unsecured creditors receive at least as much under the plan as they would receive if the debtor's assets were liquidated under chapter 7. 11 U.S.C. § 1325. Within 30 days after filing the bankruptcy case, even if the plan has not yet been approved by the court, the debtor must start making plan payments to the trustee. 11 U.S.C. § 1326(a)(1). No later than 45 days after the meeting of creditors, the bankruptcy judge must hold a confirmation hearing and decide whether the plan is feasible and meets the standards for confirmation set forth in the Bankruptcy Code. 11 U.S.C. §§ 1324, 1325. Creditors will receive 28 days' notice of the hearing and may object to confirmation. If the court confirms the plan, the chapter 13 trustee will distribute funds received under the plan "as soon as is practicable." 11 U.S.C. § 1326(a)(2). If the court declines to confirm the plan, the debtor may file a modified plan. 11 U.S.C. § 1323. The debtor may also convert the case to a liquidation case under chapter 7. (4) 11 U.S.C. § 1307(a). If the court declines to confirm the plan or the modified plan and instead dismisses the case, the court may authorize the trustee to keep some funds for costs, but the trustee must return all remaining funds to the debtor (other than funds already disbursed or due to creditors). 11 U.S.C. § 1326(a)(2).

Chapter 13 offers individuals significant advantages over liquidation under chapter 7. Individual debtors will have no direct contact with creditors while under chapter 13 protection since chapter 13 helps consolidate the debtor's loan under which the individual debtor makes the scheduled payments under the plan to a chapter 13 trustee who then distributes the payments to creditors. Chapter 13 offers individuals an opportunity to save their homes from foreclosure. By filing under this chapter, individuals can stop foreclosure proceedings and may fix delinquent mortgage payments over time. Nevertheless, they must still make all mortgage payments that come due during the chapter 13 plan on time. Another advantage of chapter 13 is that it allows individuals to reschedule secured debts (other than a mortgage for their primary residence) and extend them over the life of the chapter 13 plan. Doing this may lower the payments. Chapter 13 also has a special provision that protects third parties (like co-signers to the debtor's loan) who are liable with the debtor on consumer debts.

The discharge in a chapter 13 case is somewhat broader than in a chapter 7 case. Debts dischargeable in a chapter 13, but not in chapter 7, include debts for willful and malicious injury to property (as opposed to a person), debts incurred to pay nondischargeable tax obligations, and debts arising from property settlements in divorce or separation proceedings. 11 U.S.C. § 1328(a). The bankruptcy law regarding the scope of the chapter 13 discharge is complex and has recently undergone major changes. Therefore, debtors should consult competent legal counsel prior to filing regarding the scope of the chapter 13 discharge.

Update Dec 01, 2017: Individuals filing for bankruptcy under Chapter 13 must use a new form that presents their payment plan in a more uniform and transparent manner, and creditors will have less time to submit a proof of claim, under new bankruptcy rules and form amendments that took effect Dec. 1, 2017.

Disclaimer: This information is mainly obtained from the website of US Courts and should not be cited or relied upon as legal authority. It should not be used as a substitute for reference to the United States Bankruptcy Code (title 11, United States Code) and the Federal Rules of Bankruptcy Procedure. This article on the basics of bankruptcy should not substitute for the advice of competent legal counsel. Credit Guru Inc cannot provide legal or financial advice. Such advice may be obtained from a competent attorney, accountant, or financial adviser.

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