Debtors & Creditors, Fall 2012, BYU Law, Prof. Brook Gotberg

A Sketch of Bankruptcy Law

Debtors & Creditors, Fall 2012, BYU Law, Prof. Brook Gotberg

Contents

I.Debt Collection and State Remedies

A.FDCPA

B.Liens

1.Consensual Liens

2.Judicial Liens

3.Statutory Liens

II.Bankruptcy Overview

A.Eligibility for the Various Chapters

III.Bankruptcy Estate

A.Property of the Estate

B.Property Exempted from the Estate

1.Which State Law Governs?

2.Controlling Exemption Abuse

3.Power of Debtor to Avoid Certain Exemption-Impairing Interests

IV.Claims

A.In General

1.Order of Distribution

B.Equitable Rights

C.Determining the Amount of the Claim

1.Interest on Claims

D.Secured Claims

1.Strip Down and Strip Off

2.Valuation of the Collateral

E.Priority Claims

F.Unsecured Claims

V.Exceptions to Discharge

VI.Automatic Stay

A.Exceptions (362.b)

B.Limitations 362.c

C.Relief from Stay 362.d

D.Violation of Stay 362.k

VII.Preferences and Avoidance

A.547.b—Is the transfer a voidable preference?

B.547.c—Exceptions

C.Earmarking

D.Delayed Perfection

E.Policy

F.Letters of Credit

G.Setoff

H.Fraudulent Transfers

1.Actual Fraud

2.Constructive Fraud

VIII.Policies to Keep in Mind

A.Constitutional Background

1.Traditionalists & Proceduralists

IX.Chapter 7

A.Means Test

1.Safe Harbor

B.Residual Power of Court to Dismiss

C.Personal Property that is Encumbered

1.Forced Choice—Reaffirmation, Redemption, and Surrender

2.Redemption

3.Reaffirmation

X.Whining About BAPCPA

XI.Chapter 13

A.Eligibility

1.Abuse

B.Commencing the Case

C.Property of the Estate

D.Requirements for Plan

1.Length of Plan

2.Classifications of Unsecured Claims

E.Disposable Income

F.Modification of Plan

G.Discharge

H.Reaffirmation of Discharged Junk

I.Personal Property Encumbered by Secured Debts

1.Hanging Paragraph and Cramdown

2.Hanging Paragraph and Surrender

J.Home Mortgages under Ch. 13

1.Curing Default

XII.Chapter 11

A.Dismissal of a Case

B.Management and Control

C.Examiners

D.Creditors’ Committees

E.Adequate Protection

1.What is it?

F.Operating the Business/Cash Collateral

G.Executory Contracts and Leases

1.Contracts Not Assignable

2.Debtor Cannot Rescind Performance

3.Rejection by Debtor Lessee

4.Evicting Debtor

H.Exclusivity and Voting

1.Exclusivity

2.Solicitation

3.Voting

I.Impairment

J.Classification of Claims

K.Feasibility

L.Treatment of Secured Claims

1.Deferred Cash Payments

2.1111.b Election

M.Treatment of Unsecured Claims

1.Absolute Priority Rule

XIII.Involuntary Bankruptcy

XIV.Bankruptcy Courts

A.Basic Jurisdiction

1.Core Jurisdiction

2.Related To

B.Jurisdiction Potentially Killed When . . .

1.Withdrawal of Reference

2.Abstention

3.Existence of Arbitration Agreement

4.State’s Sovereign Immunity

C.Venue

1.Venue for Pursuing Estate’s Debtors

D.Appellate Jurisdiction

E.Jury Trial or No Jury Trial?

XV.Trans-National Bankruptcy

I.Debt Collection and State Remedies

In all of this, remember that there is leverage between debtors/creditors and an idea that one need consider the cost-effectiveness of the available remedies.

A.FDCPA

The Fair Debt Collection Practices Act exists to 1) eliminate abusive practices, 2) ensure that fair debt collectors are not competitively disadvantaged, and 3) promote consistent state action.

Creditor: Person who extends credit to debtor, but not a person to whom the debt has been assigned or transferred for the purpose of collecting the debt.

Debt Collector: Any person who uses interstate commerce or mails to regularly collect debts due to another.

§804—Acquisition of Location Information: Collector must identify himself, but not state that there is a debt, not repeatedly communicate, etc., when trying to get location information from someone who is not the debtor.

§805 Communication: Collector shall not communicate at unusual time or place—particular between 8 p.m. and 9 a.m. If there is an attorney, collector should go through them. If requested in writing by debtor that creditor stop calling, they must stop except to advise debtor that collection efforts terminated, to notify that creditor may invoke remedies, to notify debtor that collector is invoking remedy.

§806—Harassment or Abuse: No conduct that harasses, oppresses, or abuses. No violence, not profanity, not publication of lists, no advertisements, no obnoxious phone calls, no anonymous phone calls, etc.

§807—False or Misleading Representations: Basically, no hyperbole.

§808—Unfair Practices: No charging of expenses, no post-dated check monkey business, no embarrassment via post card or envelope, etc.

See the Supplement for other potentially relevant information.

B.Liens

1.Consensual Liens

A consensual lien is created from a debtor’s voluntary grant. It is not sufficient that a debt exists—the debtor must agree to some sort of security interest.

a)Security Interest in Personal Property

This falls under UCC 9. The security interest comes into existence when it attaches. Attachment happens when:

• Value has been given
• Debtor has rights in the collateral
• Debtor authenticates agreement describing collateral, or debtor has agreed and collateral is in the possession of the secured party pursuant to the agreement.

Often, value given is the final step, but debtor has rights to collateral can be the final step if this is something where the collateral is equipment or inventory to be bought in the future.

The security interest must be then perfected—filing, etc. Household goods are automatically perfected. Deposit accounts can be perfected via control over the account. Unperfected interests are enforceable, but not against third party problems in bankruptcy or against judicial liens. Upon default, the secured creditor can seize so long as there is not a breach of the peace.

b)Security Interest in Real Property

This is far more complicated. Mortgages come under many guises, and if the court recognizes something as being a mortgage, the consequences flow as normal. The creditor can have the property sold and then sue for deficiency, etc.

2.Judicial Liens

a)Prejudgment Remedies

• Replevin: Attach/seize specific property in question
• Receivership: Person appointed to maintain property
• Injunctions
• Attachment: seize any property necessary to satisfy
• Garnishment: take the property from a third-party
• Liz pendens—basically give notice to other potential creditors and make the subsequent judgment effective as regarding them.

b)Remedies with a Final Judgment

• Issuance of a writ of execution or of garnishment
• You can then serve garnishment on garnishee
• Can deliver writ of execution to sheriff, then do a levy or replevin, etc. Then there is a sale.

3.Statutory Liens

A lien is created by statute. This is done because we want to give special status to some people: IRS, mechanics, construction, dry cleaners, attorneys, domestic support, landlord, etc.

II.Bankruptcy Overview

England had involuntary bankruptcy where the proceedings were triggered by acts of bankruptcy performed by the debtor in which the debtor tried to avoid the creditor. The U.S. Constitution allowed power to Congress to make uniform laws on the subject of bankruptcy. There are advantages to doing bankruptcy law at the federal level—we do not want a race for the most creditor-friendly laws. Financial panics led to the somewhat temporary bankruptcy acts of 1800, 1841, and 1867. The Bankruptcy Act of 1898 came to stay until it was superseded in 1978 by the Bankruptcy Code, which was amended in 1984 for judicial power and amended in 2005 to help credit card companies (BAPCPA).

In the Code, Chapters 1, 3, and 5 are general provisions.

Eligibility: In general, persons or municipalities may qualify for bankruptcy. A partnership or corporation may be a person (see definition section). Estates and trusts generally are not eligible. Insurance companies and banks may not be debtors.

Petition & Automatic Stay: Filing automatically triggers a stay that protects the debtor from judicial proceedings to collect, enforce, etc. The stay is not bulletproof, but it channels claims through the bankruptcy court.

Trustee: This person liquidates non-exempt property and pays expenses and claims. Sometimes, the trustee exercises the avoiding power to grab back property transferred right before bankruptcy. Trustee can investigate the debtor and oppose discharge. The trustee can also invalidate the claims of creditors. There is a percentage scheme for the assets seized by trustee, but otherwise, the trustee gets a $60 fee. However, professionals may be hired to administrate. Trustees are not necessary in Ch. 11 cases, but can be appointed in exceptional circumstances. Unless the creditors vote on somebody else, the U.S. Trustee appoints a trustee from a panel full of people on 1-year terms. With Ch. 7, the trustee first starts as interim until the meeting of creditors. The trustee gets 25% of first $5k, 15%/$45k, 10% up to $1 million, 3% beyond. This is an incentive for the trustee to do stuff.

Meeting of Creditors: Once the debtor has filed, this meeting is convened to talk to debtor about their property and ask about transfers. Creditors can elect a trustee or allow the interim trustee to continue. This is a §341 meeting.

Claim in Bankruptcy: The creditors will have to file claims that will be allowed or disallowed by the court (default is allow unless contested). Such claims may be secured, unsecured, or partially secured/partially unsecured.

Distribution of Assets: After the secured creditors and priority claims have been paid, distribution is made on a pro rata basis. See 507.a for the priority claims. Domestic support comes first, except for administration expenses.

Discharge: In Chapter 7, the debtor gets a discharge, unless there has been a bankruptcy in the past eight years or unless there has been misconduct. Not all debts are dischargeable.

A.Eligibility for the Various Chapters

Eligibility is largely controlled by §109. Chapter 7 has some of its own elaborate things, though.

Chapter 7: This chapter is guarded by the Means Test found in §707. If the debtor’s income less the debtor’s expenses (defined in section) multiplied by 60 is not less than the lesser of 1) greater of 25% of non-priority unsecured claims or $7,025 or 2) $11,725, then the debtor does not qualify for Ch. 7. In cases where the debtor does pass the means test, the court can still decide that it would be an abuse to let the debtor file under Ch. 7. Religious/charitable donations are immune in any determination. §109 contains broad, categorical exceptions on who may file under Ch. 7.

Chapter 11: Only a railroad, debtor under Ch. 7 (excepting stock/commodity brokers), uninsured State member bank, or corporation organized under Federal Reserve Act may file here.

Chapter 12: Only a family farmer/fisherman with regular annual income may be a debtor under this chapter.

Chapter 13: Only an individual with regular income with unsecured debt less than $360,475, and secured debts less than $1,081,400 can file here.

III.Bankruptcy Estate

Commencing a bankruptcy case creates a bankruptcy estate controlled by §541. The estate is all legal or equitable interests of the debtor in property as of the commencement of the case. In Chs. 7 and 11, post-petition salary/wages are not include, but property income is. In Chs. 12 and 13, post-petition income is involved.

Butner Principle: The substantive rights of parties are determined by otherwise applicable non-bankruptcy laws unless there is a specific bankruptcy rule or principles that alters those rights.

A.Property of the Estate

All legal or equitable interests of the debtor in property as of the commencement of the case are in the estate. Post-petition earnings with Chs. 7 and 11 not included. Items included in the estate may be liquidated to pay debts. The trustee may get a court order requiring turnover of property. In Chs. 11 and 13, some property might be important to reorganization, and the trustee can have stuff back from secured creditors so long as they are protected. Retirement accounts are generally immune.

Examples:

• Dog
• Car that is underwater
• Flat iron lent out to sister
• Bank account for which Lizzie is trustee—not in estate
• Retirement account—not in estate
• Inheritance—probably in per 541.a.5

B.Property Exempted from the Estate

Exemptions are available only to individual debtors. They allow certain property to be insulated from creditors so as to protect the debtor from complete impoverishment. However, debtors can still agree to consensual liens on property that otherwise would be exempt (for instance, a homestead exemption can only protect equity in a property). Exemptions are most often used in Ch. 7, but they help in Chs. 11, 12, and 13 because they lower the liquidation value of the estate which makes it slightly easier to get the plan approved.

§522 controls exemptions and is a compromise between those who want a uniform federal exemption scheme and those who want exemptions controlled by the debtor’s domicile state. Within 522.d are the federal exemptions, but 522.b allows a state to opt-out and forbid its residents to use the federal exemptions. If the state does not opt out, debtors can choose between the federal and state exemptions. If a married couple disagree on which exemption scheme to follow, they go federal.

Although 522.d is not widely used, it is a good model. Exemption statutes specify types or classes of property that may be claimed as exempt and impose a value limit. Property that is partially exempt is sold off by the trustee, who then returns the exempt portion to the debtor. A debtor must file an exemption schedule to claim exemptions.

1.Which State Law Governs?

The law of the domicile state governs. Before BAPCPA, it was easy to change domicile. In 522.b.3 it is declared that a person must have been domiciled in the desired state for the 730 days prior to petition. If no single state was resided in during that 730 days, the 180 days preceding the 730 is used. Some states, like Texas, Florida, Iowa, Kansas, and Oklahoma have very large homestead exemptions. Thus, people might want to go there to declare bankruptcy. Pennsylvania and New Jersey do not have homestead exemptions. At the end of 522.b.3, it declares that if the domiciliary requirements block a debtor from using any state law, the federal exemption applies.

2.Controlling Exemption Abuse

• 522.o: If a debtor in the ten years before bankruptcy has converted non-exempt property into exempt property with intent to hinder, delay, or defraud creditors, the exemption is reduced by that amount. They key is that it must be done with intent to hinder, delay, or defraud creditors. In Tveten, the good doctor transferred everything into an unlimited exemption thing that was technically legal. The court frowned on that because he was getting more than just a fresh start. But, in Hanson, the court was okay where the farmers converted to life insurance and sold some things. Spendthrift trusts, offshore, and with specific instructions to the trustee can still screw the debtor.
• 522.p: If debtor acquired property within 1,215 days before petition, the state homestead exemption can only stretch to about $135k.
• 522.q: The $135k homestead exemption cap is brought to bear where the debtor has been involved with a felony.
• 522.p and 522.q contain language suggesting they apply only when the debtor has made a conscious choice to use the state exemption. Some courts have interpreted this to mean p and q don’t apply where the state has opted out. Other courts disagree.

3.Power of Debtor to Avoid Certain Exemption-Impairing Interests

a)Avoidance of Judicial Liens

522.f.1.A allows the debtor to avoid a judicial lien in exempt property to the extent that the lien impairs an exemption to which the debtor would have been entitled in absence of the lien. It applies broadly, except for domestic support. The key is to the extent. (You can’t get rid of the entire judicial lien just because it partially impairs.) Also, this can override state laws declaring pre-existing judicial liens to be valid against later purchases. There is room to argue about when the lien attaches versus whether there was a pre-existing interest.

b)Avoidance of Some Secured Liens

522.f.1.B allows avoidance of loans where the debtor keeps stuff, but the creditor has a supposed lien. These are rare, especially because of this statute, which was designed to stop predatory people. Statutory liens are not avoidable.

IV.Claims

Debt is liability on a claim. A claim is defined very broadly as a right to payment, whether or not such right is reduced to judgment, liquidated, un-liquidated, fixed, etc. Claim defined in 101. Claims may be unliquidated, contingent, unmatured, and disputed. Also, claims against the debtor’s property are claims against the debtor. This is per 102.2. The claim comes into existence when the act giving rise to liability takes place. However, case law has suggested that the claim by the EPA for cleanup compensation arises when the EPA determines that cleanup is necessary.

A.In General

The debtor fills out schedules of creditors who are then notified by the bankruptcy court. The creditor then must file a proof of claim. By default, the claim is allowed, but the debtor can object. If creditor fails to file, the claim is not allowed, though it does become discharged. Under 523.a.3, a creditor that was not mentioned on the schedule can come after the debtor later. Claims must be filed within 90 days after the first meeting of creditors, held pursuant to 341.a. For Ch. 11, the date is set by the court and may be extended for cause. In Ch.7 no asset, the creditors are notified, and are not required to file claims. This effectively extends their time to file a claim indefinitely.