Bankruptcy Info

The purpose of chapter 7, the most common type of bankruptcy, is to give the debtor a “fresh start” by extinguishing the debtor’s personal liability on debts. The discharge in Chapter 7 is only available to individuals and not business entities such as corporations. Most individual chapter 7 cases end with a discharge of debts, but some types of debts such as domestic support obligations, most taxes, and student loans, are not dischargeable. A discharge does not extinguish liens on the debtor’s property.

Qualifying to file Chapter 7

Individual debtors who earn a high monthly income may not be eligible for chapter 7. The “means test” asks whether a debtor has the financial means, after paying monthly living expenses, to repay something to the unsecured creditors. If so, then the debtor is ineligible to file chapter 7. The means test is so complex that most websites with online means test calculators are useless. In order to determine if someone is truly eligible for chapter 7, a detailed thorough examination of the debtor’s finances is required.

How Chapter 7 works

The typical chapter 7 case takes about 90 days. The debtor files a petition with the bankruptcy court in the district where the individual resides. Business debtors file where their main office or principal assets are located. The debtor files schedules listing all assets and liabilities and a statement of financial affairs. A husband and wife may file together or there may be reasons for one spouse to file individually.

Filing the petition creates an “automatic stay” which stops most creditor actions against the debtor and the debtor’s property. With few limited exceptions [such as enforcing a domestic support obligation], creditors cannot begin or continue lawsuits, repossessions, or wage garnishments while the stay is in effect.

The debtor in most individual Chapter 7 will keep their assets. Federal bankruptcy law allows an individual to retain their assets by claiming “exemptions” in the property using federal bankruptcy law or the exemptions of the debtor’s state. California law provides some of the best exemptions.

A creditor meeting is held approximately 30 days after the case is filed. The bankruptcy trustee, who was appointed at the beginning of the case, runs the creditor meeting. The debtor must attend the meeting or the case can be dismissed. Creditors may ask limited questions but rarely attend the meeting.

The trustee questions the debtor to verify the information in the debtor’s bankruptcy papers and to identify assets which may not be exempt. The trustee can sell non-exempt assets and then distribute the proceeds to creditors according to priority [i.e., past due child support is paid before general unsecured creditors]. If there is a loan against an asset, the debtor usually gets to keep the asset as long as he remains current on the loan secured by that asset.

Sixty-one days after the initial creditor meeting, the court clerk normally issues a discharge notice. A copy of the discharge is mailed to the debtor and the creditors listed in the bankruptcy papers.

Role of the Trustee

Filing a bankruptcy petition creates a “bankruptcy estate” consisting of all of the debtor’s property, including intangible assets such as lawsuits, tax refunds or other rights to payment, and patents or copyrights. The trustee is the administrator of the bankruptcy estate.

The trustee’s primary task is to conduct the creditor meeting and liquidate non-exempt assets. In the most cases, all of the debtor’s assets are exempt or subject to liens, so there are usually has no assets for the trustee to sell. If the debtor has non-exempt assets, or if the trustee recovers estate assets, the creditors are given a deadline to file a form stating the basis of their claim against the debtor or the debtor’s assets.

Discharge

A bankruptcy discharge releases the debtor from personal liability and prevents the creditors from taking any further action against the debtor individually. As a general rule, individual debtors receive a discharge in most chapter 7 cases. Business entities do NOT receive a discharge in Chapter 7.

A creditor has two options to oppose the discharge:

1. file a complaint objecting to the discharge of any of the debtor’s debts; or
2. file a complaint to determine if the creditor’s claim is an exception to the discharge.

A creditor may pursue one or both of these remedies by filing a complaint with the bankruptcy court.

The grounds for objecting to the chapter 7 discharge are narrow, and the creditor or trustee objecting to the discharge has the burden of proving the case. The most common grounds for objecting to a discharge are:

1. the debtor failed to list significant assets in the papers filed with the court
2. the debtor gave false answers in the bankruptcy papers that were material to the case
3. the debtor failed to keep and produce adequate financial records;
4. the debtor failed to explain satisfactorily a loss of assets;
5. the debtor failed to obey a lawful order of the bankruptcy court; or
6. the debtor fraudulently transferred, concealed, or destroyed property.

Certain categories of debts are not dischargeable in a chapter 7. Alimony and child support, most taxes, student loans, and debts for criminal restitution orders are not discharged. To the extent these types of debts are not paid by the trustee in the chapter 7 case, the debtor is liable for them after the bankruptcy regardless of whether the creditor files a complaint with the court.

Debts obtained by false pretenses, debts for fraud while acting in a fiduciary capacity, or debts for willful and malicious injury will be discharged unless the creditor files a timely complaint with the court. The creditor must file the complaint within 60 days after the first date of the creditor meeting. Otherwise these debts will be discharged in the chapter 7, assuming the creditor was listed in the debtor’s papers and was notified about the chapter 7 petition. In these lawsuits the creditor has the burden of proof to show the debt meets the exception to the bankruptcy discharge.

Secured debts

Secured creditors normally retain the right to seize their collateral after a discharge is granted. The debtor must decide whether to keep the asset. If a debtor returns the collateral, and if a discharge is granted, the debtor will have no further personal liability to the creditor.

A debtor wishing to keep an asset, such as an automobile, may reaffirm the debt or redeem the property. A reaffirmation is an agreement between the debtor and the creditor where the debtor promises to pay all or a portion of the money owed. The reaffirmed debt will still be owed after the discharge. In return, the creditor promises as long as payments are made, the creditor will not repossess the automobile or other property and report the loan in good standing to the credit bureau. If the debtor defaults on the payments, the creditor may repossess and sell the collateral. Unfortunately, if the sale price is not enough to pay off the debt, the debtor will owe a deficiency to the creditor.

A debtor may opt to redeem an asset by paying the fair market value in one lump sum. For example, if the balance on a car loan is $18,000 but the car is only worth $10,000, it may be sensible to redeem the car for its market value. However, most debtors who have just filed bankruptcy do not have ready cash [or a rich relative] to pay the market value in one lump sum. There are companies who provide redemption financing. Their interest rates are high, but if the gap between the loan balance and the value of the car is large enough, the total cost of a redemption loan may be less expensive than the existing loan on the car.

Chapter 11 is usually for business reorganizations. The business continues to operate, but the automatic stay gives the debtor time to restructure. Persons with debt above the dollar limits for chapter 13 may file chapter 11. However, since the proceeding is complex and expensive, Chapter 11 petitions are normally filed by corporations and other business entities.

A business typically reorganizes by: 1) drastically lowering expenses; 2) obtaining additional operating capital; or 3) liquidating all or a portion of the business. A debtor may also renegotiate loan or contract terms. The presumption in chapter 11 is that the value of the operating business is greater than selling the assets. However, a liquidating plan is permissible and allows the debtor to sell the business at a better price or under more advantageous circumstances than in chapter 7.

How Chapter 11 Works

A debtor commences a chapter 11 by filing a petition and immediately becomes a “debtor in possession.” The debtor retains management and control of assets during the reorganization without the appointment of a case trustee as in a chapter 7. A trustee may be appointed if the debtor mismanages the business or fails to comply with the duties of a debtor in possession.

A written disclosure statement and plan of reorganization are filed with the court. The disclosure statement must contain sufficient information about the debtor’s assets, liabilities, and financial affairs to enable a creditor to make an informed decision whether to accept or reject the proposed plan.

The court reviews and approves disclosure statement is before it is sent to creditors with the plan and a ballot. Creditors with “impaired” claims, meaning their rights are modified by the plan or they will be paid less than their full claim under the plan, may vote to accept or reject the plan. If there are enough votes accepting the plan, it is confirmed as a consensual plan. If not, the court determines whether the plan can be “crammed down” and confirmed over the creditor objections.

The Debtor-In-Possession

A debtor in possession has the powers of a bankruptcy trustee and owes a fiduciary duty to creditors while operating the business. Such duties include accounting for property, examining and objecting to creditor claims, and filing tax returns and monthly reports as required by the court and the United States Trustee. A debtor in possession has the power to employ attorneys, accountants, brokers, or other professionals, subject to court approval, to help with the case.

If a debtor in possession fails to comply with the U.S. Trustee requirements, fails to comply with court orders, or fails to take appropriate steps to submit a plan for confirmation, the U.S. Trustee or a creditor may file a motion to appoint a case trustee, convert the case to chapter 7, or dismiss the case. If a case trustee is appointed, then the debtor in possession losses management and control of the business and assets. A case trustee can add significantly to the expense of the Chapter 11 case.

The United States Trustee

The U.S. Trustee monitors the progress of a chapter 11. Their office reviews the debtor’s monthly operating reports, applications to employ professionals, motions for fees, and any plan or disclosure statement filed in the case. An attorney from the U.S. Trustee conducts the creditors’ meeting at the beginning of the case. Creditors may question the debtor concerning the debtor’s conduct, assets, and the plan for reorganization.

The U.S. Trustee imposes certain requirements on the debtor such as filing monthly reports of income and expenses, opening new bank accounts, and ensuring payment of current employee withholding and other taxes. While the case is pending the debtor is obligated to pay a quarterly fee to the U.S. Trustee. The amount of this fee is based upon disbursements made in the prior quarter and adds to the cost of the case.

Creditors’ Committee

An unsecured creditors’ committee sometimes plays a major role in the case. The U.S. Trustee may appoint a committee, consisting of several creditors who are owed the largest unsecured claims. The committee may consult with the debtor on the administration of the case, investigate the debtor’s conduct or business operations, and participate in the formulation of a plan. The committee may hire its own lawyer, and the legal fees are usually paid from the debtor’s bankruptcy estate. This adds to the expense of the chapter 11 case.

The Automatic Stay

The automatic stay stops creditor collections, foreclosures, and repossessions. The stay automatically goes into effect when the petition is filed. The stay provides a breathing spell so negotiations can occur to resolve the debtor’s financial difficulties.

In certain circumstances, a creditor may move to lift or modify the stay. For example, if there is no equity in a particular asset and the asset is not necessary for reorganization, the secured creditor can request an order granting relief from the automatic stay to allow the creditor to foreclose on its collateral.

Who Can File A Plan

There is no specific time for filing a plan; however, the debtor initially has an exclusive period to file a plan and disclosure statement. This period may be extended or reduced by court order. After the exclusive period expires, a creditor or the case trustee, if one is appointed, may file a plan. The debtor’s exclusive right to file a plan is an incentive for the debtor to act promptly and file a plan.

The Discharge

Confirmation of a plan discharges the debtor from any debt arising before the date of confirmation. After confirmation, the reorganized debtor and the creditors are bound by the terms of the plan. The confirmed plan creates new contractual rights, replacing or superseding prepetition contracts.

There are exceptions to the general rule that an order confirming a plan operates as a discharge of debts. Confirmation of a plan does not discharge an individual debtor from any debt that may be nondischargeable under section 523 of the Bankruptcy Code. [See the Chapter 7 page on this site that describes the debts that may be exceptions to the discharge.] Confirmation of an individual debtor’s liquidation plan will effect a discharge unless grounds would exist for denying the debtor a discharge if the case were proceeding under chapter 7 instead of chapter 11. On the other hand, plan confirmation does not discharge a corporate or business entity’s debts if the plan is a liquidation plan, as opposed to a plan where the debtor continues business operations.

Conclusion

This is a very brief overview of chapter 11, which is obviously a complex type of bankruptcy. Unlike chapter 7 or 13 cases, where most of the paperwork is done with standardized forms, a chapter 11 requires extensive pleadings, notably the plan and disclosure statement, which must be custom tailored for the case. Each step in the reorganization process may require notice to creditors and/or a court hearing which adds to the cost of the case. Since most chapter 11 cases end in dismissal or conversion to chapter 7, it is important to consult with an experienced attorney to determine if reorganization is a realistic option.

Chapter 13 is available only for individuals with regular income to fund a monthly plan payment. Therefore, a sole proprietor can file Ch 13, but a corporation or limited liability company [LLC] cannot file Chapter 13. The goal is to restructure the debtor’s obligations through a plan the debtor offers to creditors. The plan takes either a three- or five-year “commitment period” to complete before a discharge can be issued. The debtor’s income must be enough to pay regular monthly living expenses and have some funds left to make the monthly plan payments.

Objectives of a Chapter 13

The three most common reasons for filing a Chapter 13 bankruptcy:

1. To stop a foreclosure and save a home, mortgage arrears can be cured over time in a Chapter 13 plan. If a loan becomes due during the Chapter 13, the plan can provide for payment of entire debt.
2. If the value of the debtor’s home is less than the balance owed on the 1st trust deed, Chapter 13 can be used to strip offa 2nd trust deed and other junior liens after the plan is completed.
3. A debtor who earns too much income to pass the “means test” for Chapter 7 can file Chapter 13 and likely discharge some portion of the unsecured debts.

How Chapter 13 Works

The Chapter 13 petition is filed at the bankruptcy court where the debtor has a residence. A husband and wife can file a joint petition or one spouse may file individually. If only one spouse files, the income and expenses of BOTH married spouses must be disclosed in the debtor’s schedules.

Filing the petition automatically stays most creditor actions against the debtor or the debtor’s property. While the “stay” is in effect, creditors generally cannot begin or continue any foreclosure, lawsuit, repossession, or wage garnishment. Chapter 13 also provides a “co-debtor” stay that stops a creditor from trying to collect on a “consumer debt” from others who may also be liable with the debtor on the debt, such as a co-signor. A consumer debt is an obligation incurred for household or family purposes.

The debtor submits the plan, which is like a contract being offered to deal with creditor claims in the case. The plan may call for monthly payments to cure arrears on a mortgage. It can repay the current value of an automobile over time and provide only a dividend [a percentage payment] for unsecured claims. Once the plan is completed, the debtor will usually receive a discharge of the remaining unsecured debt.

A trustee is appointed to administer the case. The Chapter 13 trustee’s role is to collect the monthly plan payments from the debtor and distribute the funds to creditors according to the terms of the debtor’s plan once it has been confirmed by the court. A plan that is confirmed by the court is binding on all creditors.

Before the plan can be confirmed, a creditor’s meeting is held about 30 days after the petition is filed. The trustee runs the meeting and asks questions about the debtor’s income, his expenses, and the terms of the plan. Creditors may ask questions but typically do not appear at the meeting. Debtors are required to attend the meeting. Issues regarding the plan are usually resolved during or shortly after the creditor meeting. If there are no plan objections, a confirmation order is submitted to the court after the creditor meeting.

If the trustee or a creditor objects to the plan, a confirmation hearing is scheduled with the court. If the debtor is unable to modify the plan to satisfy the objection, the judge will determine whether the plan meets the requirements for confirmation. If the plan is not confirmed, the debtor may try to amend the plan, convert the case to Chapter 7, or let the case be dismissed. If the plan is confirmed by the judge, the Chapter 13 trustee begins distributing funds to creditors according to the plan, which is binding on all creditors. A plan may offer unsecured creditors less than 100% full payment of their claims.

The Plan and Creditor Claims

A plan is the debtor’s proposed contract for dealing with creditor claims. The plan may propose to cure arrears on real estate debts or, if the circumstances permit, to strip a junior loan off a property. A plan may repay taxes or provide for some partial payment of unsecured debts.

In order for a creditor to receive payment under the plan, they must file a proof of claim form with the court. Creditors have 90 days from the date of the creditor meeting to file a claim with the court. Unsecured creditors with dischargeable debts who miss the deadline will not receive any payment in the plan. If the debtor disagrees with the amount of the creditor’s claim, they can file an objection to the claim and ask the court to determine if the amount of the claim is correct.

The Automatic Stay

The automatic stay is like an injunction preventing a creditor from foreclosing on the debtor’s home or garnishing wages or repossessing assets. If the debtor fails to make mortgage payments after the case is filed, the mortgage creditor can bring a motion to set aside the automatic stay.

Completing The Plan

On occasion, changes in the debtor’s financial circumstances can affect the ability to make plan payments, or a debtor may have inadvertently omitted a creditor. In such instances, the plan may be modified either before or after confirmation. Plan modifications after confirmation are not limited to a motion by the debtor. The trustee may also request plan modifications if, for example, the creditors do not all file claims or the claims that are filed add up to less than the amounts listed in the debtor’s schedules.

Once the court confirms the plan, it is the debtor’s responsibility to make certain the required plan payments are all tendered to the trustee. Chapter 13 is not designed to solve financial problems that arise after the case is filed. The debtor must make regular payments to the trustee, which will require living on a fixed budget for the length of the case.

If the debtor fails to make plan payments, the debtor’s employer may be ordered to withhold plan payments from the debtor’s paycheck and send the funds to the Chapter 13 trustee. Furthermore, while confirmation of the plan entitles the debtor to keep their property, the debtor may not incur significant new debts without consulting the trustee, and a court order may be appropriate. Failure to make plan payments can result in dismissal of the case.

The Chapter 13 Discharge

The Chapter 13 debtor is entitled to a discharge upon successful completion of all payments. The discharge releases the debtor from all claims provided for in the plan or disallowed by the court. It is the creditor’s duty to file a claim in the case in order to be paid. Creditors who were provided for in the Chapter 13 plan, or creditors who failed to file a claim, may not initiate or continue legal action to collect the discharged obligations.

The debtor is not discharged from debts for alimony or child support, student loans, debts arising from death or personal injury caused by driving while intoxicated or under the influence of drugs, and debts for restitution or a criminal fine. To the extent that these types of debts are not fully paid pursuant to the Chapter 13 plan, the debtor will still be responsible for the unpaid balance on these debts after the Chapter 13 case has concluded. The 2005 amendments reduced the scope of the Chapter 13 discharge. Consequently, if a creditor proves that his claim is the result of fraud or breach of a fiduciary duty by the debtor, that debt will not be included in the Chapter 13 discharge at the end of the case.