1057A Bankruptcy Primer: Liquidation and Reorganization Under the U.S. Bankruptcy Code
Congressional research reportJan 28, 2005
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1057A Bankruptcy Primer: Liquidation and
Reorganization Under the U.S. Bankruptcy
Code
-name redactedSection Research Manager
January 28, 2005
Congressional Research Service
7-....
www.crs.gov
97-1057
CRS Report for Congress
Prepared for Members and Committees of Congress
1057A Bankruptcy Primer: Liquidation and Reorganization
Summary
This report examines the legal procedures for effecting either a liquidation or a business or
consumer reorganization under the United States Bankruptcy Code, 11 U.S.C. § 101 et seq.,
through an analysis of its individual sections.
The Code, in chapters 1, 3, and 5, establishes general procedures that are applicable to the
operative chapters. Chapter 7 governs liquidation of the debtor’s estate; chapter 11 governs
business reorganization; and, chapter 13 addresses reorganization of an individual with regular
income.
This report presents an overview of the Code’s legislative history, its procedural chapters 1, 3, and
5, and operative chapters 7, 11, and 13. Reference is made to the impact of major U.S. Supreme
Court decisions and the effect of recent legislative amendments.
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1057A Bankruptcy Primer: Liquidation and Reorganization
Contents
Introduction: Capsule History of the U.S. Bankruptcy Laws ........................................................1
Structure of the U.S. Bankruptcy Code........................................................................................3
Overview of the U.S. Bankruptcy Code Provisions Governing Liquidation and
Reorganization.........................................................................................................................4
I. Case Administration.................................................................................................................4
A. Who May Be a Debtor? ....................................................................................................4
B. Commencement of a Case ................................................................................................4
1. Voluntary Cases...........................................................................................................4
2. Involuntary Cases........................................................................................................5
C. Abstention ........................................................................................................................5
D. Debtor’s Transactions with Attorneys ...............................................................................5
E. Meeting of Creditors And Equity Security Holders............................................................6
F. Examination of the Debtor and Self-Incrimination .............................................................6
G. Conversion from One Chapter to Another .........................................................................6
1. Effect of Conversion ...................................................................................................6
2. Conversion from Chapter 7 .........................................................................................6
3. Conversion from Chapter 11........................................................................................6
4. Conversion from Chapter 13........................................................................................7
H. Dismissal .........................................................................................................................7
1. Effect of Dismissal......................................................................................................7
2. Dismissal of a Chapter 7 Case .....................................................................................7
3. Dismissal of a Chapter 11 Case ...................................................................................7
4. Dismissal of a Chapter 13 Case ...................................................................................7
I. Bankruptcy Fees ................................................................................................................8
II. United States Trustees and Officers of the Bankruptcy Estate..................................................8
A. Background on the U.S. Trustee Program .........................................................................8
B. Duties of the U.S. Trustee.................................................................................................9
C. Role of the U.S. Trustee under the Code ...........................................................................9
D. Appointment of a Trustee Other Than a U.S. Trustee.........................................................9
E. Qualifications and Eligibility Under the Code to Serve as a Trustee................................. 10
F. Removal of a Trustee....................................................................................................... 10
G. Employment and Compensation of Professionals by a Trustee......................................... 10
H. Compensation of Trustees............................................................................................... 11
III. Administrative Powers......................................................................................................... 11
A. The Automatic Stay ........................................................................................................ 11
B. Relief from Automatic Stays ........................................................................................... 13
1. Judicial Relief ........................................................................................................... 13
2. Removal of Property From the Estate; Termination of the Case ................................. 14
C. Adequate Protection........................................................................................................ 14
D. Use, Sale or Lease of Property........................................................................................ 14
E. Obtaining Credit ............................................................................................................. 15
F. Executory Contract and Unexpired Leases....................................................................... 15
G. Termination of a Debtor’s Utility Service ........................................................................ 16
IV. The Estate............................................................................................................................ 17
A. Property of the Estate ..................................................................................................... 17
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1057A Bankruptcy Primer: Liquidation and Reorganization
B. Turnover of Property of the Estate .................................................................................. 18
C. Turnover of Property by a Custodian............................................................................... 18
D. The Trustee’s Avoidance Powers..................................................................................... 19
1. Trustee as Lien Creditor and as Successor to Certain Creditors and Purchasers .......... 19
2. Statutory Liens .......................................................................................................... 19
3. Limitations on Avoiding Power ................................................................................. 20
4. Preferences ............................................................................................................... 20
5. Fraudulent Transfers and Obligations ........................................................................ 22
6. Postpetition Transactions........................................................................................... 23
7. Liability of Transferee of Avoided Transfer................................................................ 23
E. Postpetition Effect of Security Interest ............................................................................ 24
F. Setoff .............................................................................................................................. 24
G. Abandonment of Property of the Estate ........................................................................... 25
V. Creditors and Claims ............................................................................................................ 25
A. Filing of Proofs of Claims .............................................................................................. 25
B. Allowance of Claims or Interests .................................................................................... 25
C. Allowance for Administrative Expenses .......................................................................... 26
D. Sharing of Compensation ............................................................................................... 27
E. Determination of Tax Liability ........................................................................................ 27
F. Determination of Secured Status...................................................................................... 28
G. Priorities in Distribution.................................................................................................. 28
H. Claims of Codebtors; Subordination ............................................................................... 30
VI. The Debtor’s Duties and Benefits ........................................................................................ 30
A. Basic Duties ................................................................................................................... 30
B. Exemptions; Waiver of Exemptions ................................................................................ 31
C. Discharge ....................................................................................................................... 33
D. Reaffirmation Agreements .............................................................................................. 34
E. Exceptions to Discharge.................................................................................................. 34
F. Protection Against Discriminatory Treatment................................................................... 37
VII. Chapter 7—Liquidation ..................................................................................................... 38
A. Appointment of a Trustee................................................................................................ 38
1. Interim Trustee.......................................................................................................... 38
2. Election of a Trustee.................................................................................................. 38
3. Successor Trustee...................................................................................................... 38
B. Duties of the Trustee....................................................................................................... 39
C. Creditors’ Committee...................................................................................................... 39
D. Authorization to Operate Business .................................................................................. 39
E. Redemption of Personal Property.................................................................................... 40
F. Rights of Partnership Trustee Against General Partners.................................................... 40
G. Avoidance and Distribution of Certain Liens ................................................................... 40
H. Distribution of Property of the Estate.............................................................................. 41
I. Discharge......................................................................................................................... 41
1. Obtaining Discharge.................................................................................................. 41
2. Effect of Discharge.................................................................................................... 42
3. Objection To and Revocation Of the Debtor’s Discharge ........................................... 42
J. Special Tax Provisions ..................................................................................................... 43
VIII. Chapter 11—Reorganization............................................................................................. 43
A. Creditors’ and Equity Security Holders’ Committees....................................................... 44
B. Power and Duties of Committees .................................................................................... 44
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C. Appointment of Trustee or Examiner; Termination of the Trustee’s Appointment............. 44
D. Duties of a Trustee or Examiner...................................................................................... 45
E. Rights, Powers, and Duties of a Debtor in Possession...................................................... 46
F. Authorization to Operate a Business ................................................................................ 46
G. Right to be Heard............................................................................................................ 46
H. Claims and Interests ....................................................................................................... 46
I. Rejection of Collective Bargaining Agreements ............................................................... 47
J. Payment of Insurance Benefits to Retired Employees of the Debtor ................................. 47
K. The Reorganization Plan................................................................................................. 49
1. Who May File A Plan ................................................................................................ 49
2. Classification of Claims ............................................................................................ 49
3. Contents of the Plan .................................................................................................. 49
4. Impairment of Claims or Interests.............................................................................. 51
5. Postpetition Disclosure and Solicitation..................................................................... 51
6. Acceptance of the Plan .............................................................................................. 52
7. Modification of the Plan............................................................................................ 53
L. Confirmation of a Reorganization Plan............................................................................ 53
1. Confirmation Hearing ............................................................................................... 53
2. Confirmation of the Plan ........................................................................................... 53
3. Effect of Confirmation .............................................................................................. 55
4. Revocation of an Order of Confirmation.................................................................... 56
M. Implementation of the Plan ............................................................................................ 56
N. Participation in Distribution............................................................................................ 56
O. Exemption from Securities Laws .................................................................................... 56
P. Special Tax Provisions..................................................................................................... 57
IX. Chapter 13—Adjustments of Debts of an Individual With Regular Income .......................... 57
A. Stay of Action Against Codebtor..................................................................................... 58
B. The Trustee..................................................................................................................... 58
1. Appointment ............................................................................................................. 58
2. Duties of the Trustee ................................................................................................. 58
C. Rights and Powers of the Debtor..................................................................................... 59
D. Debtor Engaged in Business ........................................................................................... 59
E. Filing and Allowance of Postpetition Claims ................................................................... 60
F. Property of the Estate ...................................................................................................... 60
G. The Reorganization Plan ................................................................................................. 61
1. Filing ........................................................................................................................ 61
2. Contents of the Plan .................................................................................................. 61
3. Payments under the Plan ........................................................................................... 62
4. Modification of the Plan Before Confirmation ........................................................... 63
H. Confirmation.................................................................................................................. 63
1. Confirmation Hearing ............................................................................................... 63
2. Confirmation of the Plan ........................................................................................... 63
3. Effect of Confirmation .............................................................................................. 64
4. Modification of Plan After Confirmation ................................................................... 64
5. Revocation of a Confirmation Order.......................................................................... 64
I. Discharge......................................................................................................................... 65
1. Time and Scope of Discharge .................................................................................... 65
2. Hardship Discharge................................................................................................... 65
3. Effect of a Hardship Discharge.................................................................................. 66
4. Effect of Discharge on a Postpetition Consumer Debt ................................................ 66
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5. Revocation of Discharge ........................................................................................... 66
Contacts
Author Contact Information ...................................................................................................... 66
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1057A Bankruptcy Primer: Liquidation and Reorganization
T
his report examines the legal procedures for effecting either a liquidation or a business or
consumer reorganization under one of three of the five operative chapters of the United
States Bankruptcy Code, 11 U.S.C. § 101 et seq.1 Chapter 7 of the Code governs
liquidation of the debtor’s estate and is often referred to as a “straight bankruptcy.” Chapter 11 of
the Code governs business reorganizations, and chapter 13 governs consumer reorganizations
which conform to prescribed statutory debt limits.
Introduction: Capsule History of the U.S.
Bankruptcy Laws
The United States Constitution expressly delegates to the Congress the power “To establish. .
.uniform Laws on the subject of Bankruptcies throughout the United States.”2 It was not until
1800, however, that the United States enacted its first bankruptcy law,3 and that act was repealed
shortly thereafter in 1803.4 Enactment of the law was motivated by severe financial panics in the
1790’s that resulted in the imprisonment of many debtors.5 A second act was approved August 19,
18416 and repealed in 1843.7 Like its predecessor, the act of 1841 arose from a period of
economic hardship and was short-lived. A subsequent law, the act of 1867,8 followed the financial
disturbances incident to the Civil War. In effect for more than a decade, it was repealed in 1878.9
Thus, throughout a period of some 78 years, a national bankruptcy law was operative for only 16.
After the repeal of the act of 1867, a period of some 20 years would pass before another
bankruptcy act was forthcoming—the act of 1898.10
The act of 1898 followed a depression of several years duration beginning in 1893. Among the
reasons cited by Congress in support of a new and permanent bankruptcy law was the increasing
availability to the public of an expanding network of federal courts, and increasing national
growth of both population and commerce. 11 The 1898 Act was amended at various times but
underwent a comprehensive revision and modernization in 1938.12 These amendments, effected
by a law known as the Chandler Act, recast the relief provisions that had been added to the 1898
Act, established wage earner plans, and substituted or replaced provisions dealing with real
1
Chapters 1, 3, and 5 of the Bankruptcy Code establish general procedures which are applicable to each of the
operative chapters, i.e., chapters 7, 9, 11, 12, and 13.
Chapter 9, which deals with adjustments of debts of a municipality, and chapter 12, which deals with family farmer
reorganization, are not addressed in this report. Also omitted are subchapters dealing with stockbroker liquidation, 11
U.S.C. §§ 741 - 752; commodity broker liquidation, 11 U.S.C. §§ 761 - 766; and railroad reorganization, 11 U.S.C. §§
1161 - 1171.
2
Article I, section 8, clause 4.
3
2 Stat. 19 (April 4, 1800).
4
2 Stat. 248 (December 9, 1803).
5
1 Norton Bankr. L. & Prac. § 1.02
6
5 Stat. 440 (August 19, 1841).
7
5 Stat. 614 (March 3, 1843).
8
14 Stat. 517 (March 2, 1867).
9
20 Stat. 99 (June 7, 1878).
10
30 Stat. 544 (July 1, 1898).
11
H.Rept. 1228, 54th Congress., lst Session Incorporated in H.Rept. 65, 55th Congress, 2d Session 29-30 (1897).
12
52 Stat. 840 (June 22, 1938).
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1057A Bankruptcy Primer: Liquidation and Reorganization
property arrangements and corporate reorganizations. Changes in the act subsequent to the 1938
amendments were relatively slight.13
Eventually, Congress perceived a need to modernize the bankruptcy laws, and, in 1970, it created
a Commission on the Bankruptcy Laws of the United States to study and recommend changes in
the law.14 The Commission became operational in June, 1971, and filed its final report with the
Congress on July 30, 1973.15
Among the reasons expressed by Congress for enactment of a new and modernized Bankruptcy
Code was that the substantive law of bankruptcy embodied in the act of 1898 reflected “the horse
and buggy” era of consumer and commercial credit; that the widespread adoption of the Uniform
Commercial Code in the early 1960’s changed and expanded commercial financing; that
bankruptcy relief for the consumer debtor was inadequate; and, that the bankruptcy court system
was too frequently an inefficient and unfair forum.16
Hence, the stage was set for a national debate on the bankruptcy laws. In 1978, Congress repealed
the act of 1898 in its entirety and enacted the present Bankruptcy Code, the Bankruptcy Reform
Act of 1978.17
Since the Code’s enactment in 1978, it has undergone several major amendments. The
Bankruptcy Amendments and Federal Judgeship Act of 198418 cured constitutional deficiencies in
the bankruptcy court system19 and made a wide variety of substantive and technical amendments
to the Code. The Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act
of 1986 instituted a nation-wide U.S. Trustee system and added a new operative chapter
governing reorganizations of “family farmers.”20 In 1988, Congress enacted several substantive
amendments to the Code, including the Retiree Benefits Bankruptcy Protection Act, which added
a new section governing the rights of retirees of a corporation undergoing a chapter 11
reorganization.21
During the 101st Congress, more amendments were enacted. In addition to technical amendments
affecting swap agreements and forward contracts,22 legislation was passed altering the
dischargeability under chapters 7 and 13, respectively, for debts for liability incurred while
13
Among post-1938 amendments were major revisions to the provisions governing municipal reorganization under
chapter 9 which were enacted in response to New York City’s financial crisis. See, P.L. 94-260, 90 Stat. 315 (1976).
14
P.L. 91-354, 84 Stat. 468 (July 24, 1970).
15
Report of the Commission on Bankruptcy Laws, H.R. Doc. No. 137, parts I and II, 93rd Congress, lst Session (1973).
16
H.Rept. 95-595, 95th Congress, lst Session 4-5 (1977)(report of the House Committee on the Judiciary to accompany
H.R. 8200.) See also, S.Rept. 95-989, 95th Congress, 2d Session (1978)(report of the Senate Committee on the
Judiciary to accompany S. 2266.) These reports comprise, in part, the legislative history of the Bankruptcy Reform Act.
17
P.L. 95-598, 92 Stat. 2549 (November 6, 1978).
18
P.L. 98-353, 98 Stat. 333 (July 10, 1984).
19
See Northern Pipeline Construction Co. V. Marathon Pipe Line Co., 458 U.S. 50 (1982).
20
P.L. 99-554, 100 Stat. 3088 (October 27, 1986). Originally designated to sunset on October 1, 1993, chapter 12 has
been temporarily extended eleven times.
21
P.L. 100-334, 102 Stat. 610 (June 16, 1988), codified at 11 U.S.C. § 1114. See also, P.L. 100-506, 102 Stat. 2538
(Oct. 18, 1988)(involving executory contract licensing rights to intellectual property), and P.L. 100-597, 102 Stat. 3028
(Nov. 3, 1988)(amending chapter 9 provisions governing municipal reorganization).
22
P.L. 101-311, 104 Stat. 267 (June 25, 1990).
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driving while intoxicated, criminal restitution, and student loans.23 The Comprehensive Thrift and
Bank Fraud Prosecution and Taxpayer Recovery Act of 199024 made many amendments designed
to strengthen criminal prosecution of and recovery from crimes against banks.
The most recent congressional enactment making wide-reaching substantive and procedural
amendments to the Code took place pursuant to the Bankruptcy Reform Act of 1994.25 Among its
highlights was the creation of a National Bankruptcy Review Commission, patterned after the
1970 Commission, to study and report within two years recommendations for legislative or
administrative action to the President, the Congress, and the Supreme Court. The Commission
issued its report on October 20, 1997.26 In a lengthy report of approximately 1300 pages, the
Commission adopted as many as 172 recommendations dealing with, inter alia, consumer
bankruptcy, business bankruptcy, municipal bankruptcy, and, bankruptcy jurisdiction, procedure,
and administration. On the subject of consumer bankruptcy reform, the Commission could not
reach consensus. Recommendations were adopted by a 5-4 split vote, which undermined the
persuasive value and influence on the Congress of the Commission’s report.27
Important procedural reform effected by the 1994 Act included express authorization for
bankruptcy courts to conduct jury trials with the consent of parties thereto. The act also
encouraged nation-wide creation of Bankruptcy Appellate Panels as intermediary, specialized
review tribunals positioned between U.S. district court and the circuit courts of appeals. This law
also incorporated sanctions into the Code for negligent or fraudulent bankruptcy petition
preparers and amends federal criminal law to establish additional penalties for bankruptcy fraud.
The 105th Congress considered, but did not enact, major bankruptcy reform legislation. 28 Several
provisions were enacted, however, including the Religious Liberty and Charitable Donation
Protection Act,29 permitting debtors to make substantial charitable donations prior to filing and
during the course of a chapter 13 reorganization. Other provisions narrowed the dischargeability
of student loans, and effected amendments to the automatic stay. During the 106th and 107th
Congresses, bankruptcy reform legislation, including provisions to effect major changes to
consumer bankruptcy, continued to be debated. Enactment did not occur and reform proposals are
still under consideration in the 109th Congress.
Structure of the U.S. Bankruptcy Code
The Code is divided into eight chapters—chapters 1, 3, 5, 7, 9, 11, 12, and 13. Chapters 1, 3, and
5 govern general procedures involving management and administration of the bankruptcy estate
which are applicable, as specified, to the operative chapters. Chapters 7 through 13, the operative
23
P.L. 101-508 (Nov. 5 1990), the Omnibus Budget Reconciliation Act; P.L. 101-581 (Nov. 15, 1990), the Criminal
Victims Protection Act of 1990; P.L. 101-647 (Nov. 29, 1990), the Crime Control Act of 1990.
24
Title XXVII of P.L. 101-647.
25
P.L. 103-394, 108 Stat. 4106 (October 22, 1994).
26
“Bankruptcy: The Next Twenty Years,” National Bankruptcy Review Commission Final Report (GPO, October 20,
1997).
27
See, “Recommendations for Reform of Consumer Bankruptcy Law by Four Dissenting Commissioners,” id.
28
See, H.Rept. 105-794, 105th Congress, 2d Sess. (1998), Conference Report to accompany H.R. 3150, the Bankruptcy
Reform Act of 1998.
29
P.L. 105-183, 112 Stat. 517 (June 19, 1998).
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chapters, address the different forms of bankruptcy relief, i.e., liquidation or the various
categories of reorganization—municipal, business, family farmer, and consumer.
Also codified under Title 11 of the United States Code are Rules of Bankruptcy Court and
officially authorized bankruptcy forms.
Examined below are substantive highlights of the procedural and operative provisions of the U.S.
Bankruptcy Code governing liquidation and reorganization.
Overview of the U.S. Bankruptcy Code Provisions
Governing Liquidation and Reorganization
I. Case Administration
A. Who May Be a Debtor?
Any debtor that is a person, partnership or corporation residing, domiciled, having property or a
place of business in the United States may file for relief under the Bankruptcy Code, except that:
1. Several entities may not file for liquidation under chapter 7, namely, a railroad, an insurance
company, bank, savings bank, cooperative bank, savings and loan association, homestead
association, small business investment company, credit union, or federally guaranteed industrial
bank.
2. A chapter 11 reorganization may only be filed by debtors that may file under chapter 7 (with
the exception of railroads, stockbrokers, and commodity brokers who may also file under chapter
11.)
3. A chapter 13 reorganization is limited to an individual (and spouse) with regular income
(except stockbrokers and commodity brokers) whose aggregate unsecured and secured debts are
less than $307,675 and $922,975 respectively.
4. No individual or family farmer may file who has been a debtor in a case pending in the
preceding 180 days if the case was dismissed for willful failure of the debtor to abide by orders of
the court, or to appear before the court in proper prosecution of the case, or if the debtor obtained
a voluntary dismissal following the filing of a request for relief from the automatic stay. 11
U.S.C. § 109.
B. Commencement of a Case
1. Voluntary Cases
A voluntary case is commenced when the debtor files a petition under the operative chapter of the
Code in which the debtor desires to proceed. A husband and wife may file jointly, in which case
the court will determine the extent, if any, to which the debtor’s estate shall be consolidated.
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Commencement of a voluntary case constitutes an order for relief. 11 U.S.C. §§ 301, 302.
2. Involuntary Cases
An involuntary, that is, a creditor-initiated bankruptcy may be commenced under chapter 7 or 11
of the Code. Among the creditor groups entitled to file is a group comprised of three or more
creditors who hold at least $12,300 in noncontingent, nondisputed claims. Farmers, family
farmers, and non-moneyed, noncommercial corporations may not be forced into bankruptcy
involuntarily.
Although creditors may file a petition under the Code, it does not operate as an order for relief.
The debtor may controvert the petition at trial, and until the court finds for the creditors and
enters an order for relief, the debtor may operate its business as if a petition had not been filed.
The court may, however, appoint either an interim trustee or a U.S. Trustee to manage the estate
of the debtor pending an order for relief if the court believes it is necessary to preserve the estate.
The court may enter an order for relief against a debtor if, at trial, it finds that the debtor is
generally not paying debts as they become due, or, if, within 120 days before the filing of the
petition, a custodian was appointed or took possession of substantially all of the debtor’s property.
If the court dismisses an involuntary petition against a debtor after trial other than on consent of
all petitioners and the debtor, it may award the debtor costs, a reasonable attorney’s fee, and, if
any of the petitioners filed in bad faith, damages or punitive damages. 11 U.S.C. § 303.
C. Abstention
The bankruptcy court may dismiss a case or suspend all proceedings if, among other reasons, it
finds that to do so would be in the best interests of creditors and that the debtor would be better
served thereby. 30 An order dismissing or suspending an action is nonreviewable by appeal or
otherwise. 11 U.S.C. § 305.
D. Debtor’s Transactions with Attorneys
Attorneys representing debtors are required to file a statement of their compensation agreement
with the court. It the court finds that the agreed to compensation exceeds the reasonable value of
the services to be provided by the attorney, the court may cancel the agreement or order the return
of the excess compensation paid to either the estate, or to the entity that made the payment if the
property would not have come into the estate. 11 U.S.C. § 329.
30
An example of a situation where a court may find that a suspension or dismissal is warranted might arise when an
arrangement is being worked out by the creditors and the debtor out of court, but an involuntary case has been
commenced by a few recalcitrant creditors to provide a basis for future threats to extract full payment. The less
expensive out-of-court workout may better serve the interests of the case. S.Rept. 95-989, supra note 16 at 36.
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E. Meeting of Creditors And Equity Security Holders
Within a reasonable time after an order for relief is entered, the United States Trustee must
convene and preside at a meeting of creditors. The Trustee may order a meeting of any equity
security holders. The bankruptcy court may not preside over or attend these creditor meetings.
In a chapter 7 case, the trustee must orally examine the debtor to ensure that he or she is aware of:
the potential consequences of seeking a discharge in bankruptcy, including the effects on credit
history; the debtor’s ability to file under a different chapter; the effect of receiving a discharge;
and, the effect of reaffirming a debt that would otherwise be dischargeable in bankruptcy. 11
U.S.C. § 341.
F. Examination of the Debtor and Self-Incrimination
The debtor must be available for examination under oath at the creditor’s meeting. “Use”
immunity may be granted to all persons required to testify, be examined, or provide information
in a bankruptcy case. 11 U.S.C. §§ 343, 344.
G. Conversion from One Chapter to Another
1. Effect of Conversion
After notice, a case may be converted from one chapter to another. Conversion does not change
the date of the original filing of the petition, the commencement of the case, or the order for
relief, but it does terminate the services of the trustee serving in the case prior to conversion.
Claims against the debtor that arise after the petition but before the conversion shall be treated as
prepetition claims. 11 U.S.C. § 348.
2. Conversion from Chapter 7
A debtor may convert a case from chapter 7 to one under chapters 11, 12, or 13, if the case has
not already been converted from one of those chapters. A party in interest may request a
conversion of the debtor’s case from chapter 7 to chapter 11, but not to chapter 12 or 13. 11
U.S.C. § 706.
3. Conversion from Chapter 11
A debtor may convert a case from chapter 11 to one under chapter 7 unless (1) the debtor is not in
possession of the estate, (2) the case was filed as an involuntary case under chapter 11, or (3) the
case was already converted to one under chapter 11 upon another party’s request.
The court itself may convert the case from a chapter 11 reorganization to a chapter 7 liquidation
“for cause,” which includes continuing loss or diminution of the estate and absence of a
reasonable likelihood of rehabilitation; inability to effectuate a plan; unreasonable delay by the
debtor that is prejudicial to creditors; or, failure to meet the statutory requirements to effect and
implement a reorganization plan. The court may not convert a case to chapter 7 if the debtor is a
farmer, and may convert a case to chapter 12 or 13 only if the debtor requests the conversion.
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A case may also be converted to one under chapter 7 on request of the U.S. Trustee when a debtor
fails to file its list of creditors, schedule of assets and liabilities, and other required information in
conformance with statutory requirements. 11 U.S.C. § 1112.
4. Conversion from Chapter 13
A debtor under chapter 13 may convert a case to one under chapter 7 at any time. Property of the
estate in the converted case shall consist of property as of the date of the initial filing. If the
conversion occurs in “bad faith,” property of the estate may be valued as of the date of
conversion, thereby encompassing after-acquired property. 11 U.S.C. § 348(f).
A party in interest in chapter 13 may request that the court convert the case to one under chapter 7
“for cause,” but may request conversion to either chapter 11 or 12 at any time before confirmation
of a plan. The court may not convert a chapter 13 case to another chapter if the debtor is
otherwise ineligible to be a debtor thereunder, or if the debtor is a farmer, unless the debtor
requests such conversion. 11 U.S.C. § 1307.
H. Dismissal
1. Effect of Dismissal
Unless otherwise ordered by the court, dismissal of a case does not bar discharge in a later case of
debts that were dischargeable in the dismissed case.
Dismissal does reinstate prior, superseded custodianships and proceedings, voided transfers and
liens, and revests estate property in the entity in which the property was vested immediately prior
to the commencement of the case. 11 U.S.C. § 349.
2. Dismissal of a Chapter 7 Case
The court may dismiss a case only “for cause,” including unreasonable delay by the debtor that is
prejudicial to creditors; nonpayment of fees; or, failure by the debtor to file a list of creditors, a
schedule of assets and liabilities, and other necessary information.
The court, on its own motion, or on the motion of a U.S. Trustee, may dismiss a case filed by an
individual debtor whose debts are primarily consumer debts if it finds that granting relief would
be a substantial abuse of the provisions of chapter 7. There is a presumption in favor of granting
the requested relief. 11 U.S.C. § 707.
3. Dismissal of a Chapter 11 Case
As in the case of conversions requested by a party other than a debtor, the court may dismiss a
case only after notice and hearing “for cause.” 11 U.S.C. § 1112.
4. Dismissal of a Chapter 13 Case
The court may dismiss a case only “for cause,” including—
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•
unreasonable delay or gross mismanagement by the debtor that is prejudicial to
creditors;
•
nonpayment of necessary fees and charges;
•
failure to file a plan;
•
failure to begin payments required by a plan;
•
denial of confirmation of a plan;
•
material default by the debtor under a confirmed plan; or
•
continuing loss to or diminution of the estate and absence of a reasonable
likelihood of rehabilitation.
Additional grounds for dismissal in a chapter 13 case include the debtor’s failure to file required
information concerning consumer debt. 11 U.S.C. § 1307.
I. Bankruptcy Fees
Parties commencing a bankruptcy case must pay the clerk of the bankruptcy court the prescribed
filing fees. Currently, filing fees are $155 for a case under chapter 7 or 13, and $800 for a case
under chapter 11 that does not concern a railroad. An individual filing a voluntary case or a joint
case may pay the fee in installments. For converting, on request of the debtor, a case from chapter
7 or 13 to one under chapter 11, the debtor must pay a fee of $645.
An individual filing under chapter 11 may pay the filing fee in installments. In addition to a filing
fee, chapter 11 debtors pay a quarterly fee to the U.S. Trustee for each quarter until a plan is
closed or the case is converted or dismissed. The fee is derived from a sliding scale based upon
the amount of disbursements per quarter. 28 U.S.C. § 1930.
In chapter 13 cases, a standing trustee is permitted to charge a percentage fee, established by the
U.S. Attorney General, not to exceed ten percent, from all payments received by the trustee for
disbursement under the reorganization plan. 28 U.S.C. § 586.
II. United States Trustees and Officers of the
Bankruptcy Estate
A. Background on the U.S. Trustee Program
When the Bankruptcy Reform Act was enacted in 1978, one of its basic goals was to remove
bankruptcy judges from case administration.31 Congress found bankruptcy judges to be too mired
in the administrative details of bankruptcy cases and the creation of the office of the U.S. Trustee
was designed to permit bankruptcy judges to handle only judicial matters.32
31
32
124 Cong. Rec. H11088, 11116 (daily ed. Sept 28, 1978); 124 Cong. Rec. S17432 (daily ed. Oct. 6, 1978).
H.Rept. 95-595, supra note 16 at 88-91.
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Under the 1978 Act, the U.S. Trustee program was implemented on an experimental basis with 10
“pilot” districts, one in each federal judicial circuit. The Bankruptcy Judges, United States
Trustees, and Family Farmer Bankruptcy Act of 1986 established the U.S. Trustee system
permanently and nation-wide.33
United States Trustees are appointed by, are subject to removal by, and remain under the direction
of the United States Attorney General through the Executive Office for United States Trustees in
the Department of Justice.
The U.S. Trustee system is funded through bankruptcy filing fees and “user” fees, that is,
percentage fees charged by a trustee administering either a chapter 12 or 13 reorganization plan
which are remitted to the United States Trustee System Fund. 28 U.S.C. §§ 586, 589a.
B. Duties of the U.S. Trustee
Although U.S. Trustees may serve directly as trustees in a chapter 7, 11, 12, or 13 bankruptcy,
their duties are administrative.34 They establish and supervise panels of private trustees that are
eligible to serve in chapter 7 liquidations, and supervise the administration of cases and trustees
under chapters 7, 11, 12 and 13. U.S. Trustees may, when necessary, appoint one or more
individuals to serve as standing trustees in chapter 12 or 13 cases. 28 U.S.C. §§ 581, 586.
Pursuant to amendments of the Bankruptcy Reform Act of 1994,35 the U.S. Trustee is directed to
review professional fee applications under procedural guidelines adopted by the Executive Office
of the U.S. Trustee. 11 U.S.C. § 321;
C. Role of the U.S. Trustee under the Code
In addition to those responsibilities specifically delegated to the U.S. Trustee under the operative
chapters of the Code, the U.S. Trustee is permitted to raise and appear and be heard on any issue
in any case under the Code. 11 U.S.C. § 307.
D. Appointment of a Trustee Other Than a U.S. Trustee
A trustee is always appointed to oversee a chapter 7 liquidation and a reorganization under
chapter 13. A trustee is appointed in a chapter 11 reorganization only “for cause” or when the
court finds that to do so would be in the best interest of creditors. 11 U.S.C. §§ 702, 1104, 1302.
33
Note 20, supra.
34
A detailed examination of the U.S. Trustee program, including the U.S. Trustee’s administrative responsibilities
under Title 28 of the U.S. Code, is beyond the scope of this report. Emphasis herein is on the respective roles of a U.S.
Trustee, a private trustee, or a standing trustee in a liquidation or reorganization under the Code.
35
Note 25, supra at § 224(a).
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E. Qualifications and Eligibility Under the Code to Serve as a
Trustee
In addition to those qualifications which may be established by the Attorney General to guide the
U.S. Trustee in selecting panels of private trustees, the Code itself contains certain eligibility
criteria. An individual must reside in the judicial district or adjacent to the district in which the
case is pending, and may not have served as an examiner in the case. A person selected to serve as
trustee must file with the court a bond (the amount of which is determined by the U.S. Trustee) in
favor of the United States conditioned on the faithful performance of official duties. 11 U.S.C. §§
321, 322.
F. Removal of a Trustee
The court may, after notice and hearing, remove a trustee, other than a U.S. Trustee, for cause. 11
U.S.C. § 324.
G. Employment and Compensation of Professionals by a Trustee
The trustee is permitted, with the court’s approval, to employ attorneys, accountants, appraisers,
or other professionals to assist in the administration of the bankruptcy case. When a trustee
operates a debtor’s business, and the debtor had regularly employed such professionals, the
trustee may retain or replace them. The court may authorize the trustee to serve as attorney or
accountant to the estate if it would be in the best interests of the estate.
The court oversees compensation of professionals retained by a trustee. 11 U.S.C. §§ 327, 328.
The court may award reasonable compensation for services rendered by a trustee or professional
or paraprofessional and reimbursement for actual, necessary expenses. 36
The court may, on its own motion or on motion of the U.S. Trustee, or any party in interest, award
compensation that is less than the amount requested.
Factors to be considered by the court measure the nature, extent, and value of the services,
including the time spent rendering the service and the rate charged; whether the services were
necessary or beneficial towards completion of the estate; whether the services were performed
within a reasonable amount of time commensurate with the complexity, importance and nature of
the problem; and, whether the compensation is reasonable based on the customary rates charged
by comparably skilled practitioners in cases other than bankruptcy.37 11 U.S.C. § 330.
36
Despite what many believe to be a drafting error by Congress, the express language of the Code does not authorize
payment for a debtor’s attorney from estate funds unless the attorney is employed as authorized under § 327 or, in a
chapter 7 case, is employed by the trustee and approved by the court. Lamie v. U.S. Trustee, 124 S. Ct. 1023 (2004).
37
Express standards for court review of fee awards was effected by § 224 of the 1994 Bankruptcy Reform Act, supra
note 25.
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H. Compensation of Trustees
The Code imposes limits upon private trustee compensation in chapters 7 and 11. A trustee may
not realize more than 25% on the first $5,000 or less, 10% on any amount in excess of $5,000 but
less than $50,000, 5% on any amount in excess of $50,000 but less and $1,000,000, and
compensation not to exceed 3% of money in excess of $1,000,000 disbursed by the bankruptcy
estate. 11 U.S.C. § 326.
A chapter 7 trustee also receives $45 to be paid from the filing fee, which may be increased by an
additional $15 from fees prescribed by the Judicial Conference of the United States. 11 U.S.C. §
330(b).38
III. Administrative Powers
A. The Automatic Stay
The automatic stay is triggered when an order for relief is filed. The stay is generally
acknowledged to be one of the fundamental debtor protections provided by the bankruptcy laws.
It gives the debtor a “breathing spell” from his creditors because it stops all collection efforts, all
harassment, and all foreclosure actions. It permits the debtor to attempt a repayment or
reorganization plan, or simply to be relieved of the financial pressures that drove him into
bankruptcy. 39
By halting all collection activities, the stay provides creditor protection as well. Without it, certain
creditors would be able to pursue their own remedies against the debtor’s property. The stay
prevents the piecemeal dismantling of the debtor’s property in ways that would be preferential to
some creditors and detrimental to others.
The bankruptcy petition, which in a voluntary case is the order for relief, operates to stay:
38
39
•
all prepetition process or proceedings of an administrative or judicial nature, or to
recover a claim, that were or could have been brought before commencement of
the case;
•
enforcement of prepetition judgments against the debtor or his property;
•
acts to obtain possession of estate property;
•
acts to create, perfect or enforce property liens securing prepetition claims;
•
acts to create, perfect, maintain, or continue perfection, or enforce any lien
against estate property;
•
acts to collect, assess or recover on prepetition claims;
Id. at § 117.
H.Rept. 95-595, supra note 16 at 340.
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•
the set-off of prepetition debts owed to debtor against any claim against the
debtor;40
•
United States Tax Court proceedings.
But, there are exceptions to actions stayed by the order for relief. They include:
•
criminal proceedings;
•
actions to establish paternity; to establish or modify an order for alimony,
maintenance or support; or, to collect alimony, maintenance or support from
nonestate property;41
•
actions to enforce a governmental unit’s police or regulatory power, or a
judgment (other than a money judgment) obtained by such power;42
•
the set-off of any mutual debt and claim for specified transactions involving
commodity brokers, forward contracts merchants, stockbrokers, securities
clearing agencies, repo participants, or swap agreement participants;
•
actions by the Secretary of Housing and Urban Development to foreclose or take
possession in a case of a loan insured under the National Housing Act;
•
an audit by a governmental unit to determine tax liability; the issuance of tax
deficiency notice; a demand for tax returns; or, the making of an assessment and
issuance of a notice for demand and payment (although tax liens that might
otherwise attach to estate property will be stayed unless such tax is
nondischargeable and such property or its proceeds are transferred out of the
estate and revested in the debtor);43
•
actions by a lessor to the debtor under a lease of nonresidential real property that
has terminated before or during the case to obtain possession of such property;
•
presentation, notice, and protest of the dishonoring of a negotiable instrument;
40
A creditor bank did not violate the automatic stay by protecting its right to setoff by temporarily withholding
payment of a debt to the debtor as it sought relief from the automatic stay. The debtor had defaulted on loan payments
to the bank, which placed a postpetition “administrative hold” on the debtor’s bank account. Citizens Bank of Maryland
v. Strumpf, 116 S. Ct. 286 (1995).
41
The automatic stay is inapplicable to actions to collect alimony or child support from nonestate property. In chapter
7, nonestate property is property acquired by the debtor postpetition. But, in chapter 13, a debtor pledges disposable
postpetition property to the reorganization plan. Prior to the child support and alimony amendments in § 304 of the
Bankruptcy Reform Act of 1994, the Code was silent on the status of these payments in the bankruptcy scheme. Even
though they were nondischargeable, there was often a substantial delay in the collection process. The amendments
clarify that child support and alimony payments, in addition to being nondischargeable, are priority payments in
bankruptcy. Subsection 304(g) of the act also confers upon child support creditors or their representatives permission to
appear and intervene in bankruptcy court proceedings “without meeting any special local court rule requirement for
attorney appearances” upon filing of a form that contains information detailing the debt, its status and other
characteristics.
42
This exception was amended in 1998 to include certain actions by “any organization exercising authority under the
Convention on the Prohibition of the Development, Production, Stockpiling and use of Chemical Weapons and on
Their Destruction” to enforce the organization’s police or regulatory power derived from the chemical weapons treaty.
P.L. 105-277, § 603 (October 21, 1998).
43
This exception to the stay was expanded from the issuance of a notice of tax deficiency by § 116 of the 1994 Reform
Act, supra note 25.
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•
actions by a state licensing agency regarding the accreditation status or licensure
of a debtor education institution, or by a guaranty agency or the Secretary of
Education regarding the eligibility of the debtor to participate in authorized
programs; or
•
the creation or perfection of a statutory lien for an ad valorem property tax
imposed by the District of Columbia, or a political subdivision of a state, if such
tax comes due after the filing of the petition.
11 U.S.C. § 362(a)&(b).
B. Relief from Automatic Stays
1. Judicial Relief
A creditor, or other party in interest, may request the court to terminate, modify, annul, or
condition a stay with respect to a specific asset of the debtor. The court, after notice and hearing,
may grant relief:
a) for cause, including the lack of adequate protection of the interested party’s interest in such
property; or
b) with respect to a stay of an act against property, if—
(i) the debtor has no equity in such property;
(ii) such property is not necessary to a reorganization; or
(iii) a “single asset” debtor, has not, within 90 days of the order for relief, filed a feasible plan
for reorganization, or has commenced monthly payments to secured creditors which represent
an amount equal to interest at a current fair market rate on the value of the creditor’s interest
in the real estate.44
If the court does not rule within 30 days from a request by motion for relief from the stay, the stay
is automatically terminated with respect to the property in question. The court may, however,
grant relief without a hearing when necessary to prevent irreparable damage to the interest of an
entity in property if the damage will occur before there is an opportunity for notice and hearing.
11 U.S.C. § 362(d),(e)&(f).
44
Provisions regarding “single asset” debtors were added to the Code by virtue of § 218 of the 1994 Reform Act.
“Single asset real estate” means a single property which generates substantially all of the gross income of a debtor; a
property on which no substantial business is being conducted by a debtor other than the operation thereof; and, a
property having aggregate noncontingent, liquidated secured debts in an amount less than $4,000,000. 11 U.S.C. §
101(51B).
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2. Removal of Property From the Estate; Termination of the Case
A stay may terminate by reason of provisions relating to its duration, for example, the property is
no longer property of the estate. The stay of any other act continues until the case is closed,
dismissed, or a discharge is granted or denied. 11 U.S.C. § 362(c).
C. Adequate Protection
The concept of “adequate protection” of a secured creditor’s interest in property is derived from
the fifth amendment protection of property interests as enunciated by the U.S. Supreme Court.45
When an automatic stay, or the sale, use or lease of estate property by the trustee or debtor in
possession results in a decrease in value of the legal or equitable interests of the secured creditor
or co-owner with the debtor of such property, such decrease in value may be adequately protected
by:
•
periodic cash payments to the extent of such decrease; or
•
providing additional or replacement liens to the extent of such decrease; or
•
granting other relief which results in the realization by the secured creditor of the
“indubitable equivalent” of such entity’s interest in the property. 46
11 U.S.C. § 361.
D. Use, Sale or Lease of Property
The Code sets out in detail the rights of a trustee or debtor in possession to use, sell, or lease
property of the estate in the operation of the debtor’s business in either a liquidation or
reorganization. The thrust of this section is the protection of secured creditors and other parties
who have interests in the property involved, and they are framed primarily as limitations or
conditions upon the debtor’s right to use, sell, or lease estate property.
Estate property may be used, sold, or leased by the trustee:
•
other than in the ordinary course of business only after notice and hearing;
•
in the ordinary course of business, without notice and hearing if the operation of
the debtor’s business is authorized and the court has not ordered otherwise;
•
on consent of all parties having an interest, or on court authority after notice and
hearing, if the property involved is defined as cash collateral, namely, cash,
negotiable instruments, documents of title, securities, deposit accounts, or other
cash equivalents;
45
See United States v. Security Industrial Bank, 459 U.S. 70 (1982); Wright v. Union Central Life Ins. Co., 311 U.S.
273, rehearing denied 312 U.S. 711 (1940); Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935). See
also, Sen. Rep. 95-989, supra note 16 at 49.
46
The “indubitable equivalent” criterion does not entitle an undersecured creditor to compensation for the delay caused
by the automatic stay in foreclosing on the collateral, often referred to as “lost opportunity costs.” United Saving
Assoc. of Texas v. Timbers of Inwood Forest Assoc., 484 U.S. 365 (1988).
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•
if it is not inconsistent with any relief from an automatic or other stay granted to
a party having an interest in estate property;
•
if adequate protection of an entity’s interest in the property has been provided.
11 U.S.C. § 363(a)-(e).
Subject to specified conditions, the trustee may sell property free and clear of the interests of
spouses and co-owners so long as they receive either a right of first refusal at the price at which
the sale is being consummated, or an appropriate portion of the sale proceeds. 11 U.S.C. §
363(h),(i),(j).
E. Obtaining Credit
Unless the court orders otherwise, a trustee authorized to operate a debtor’s business may obtain
and incur unsecured credit and debt in the ordinary course of business. In order to enhance a
debtor’s ability to obtain credit throughout the course of a bankruptcy, such credit is treated as a
high priority administrative expense, which means it is paid out of the estate’s assets before other
pre-existing claims. Credit may be obtained and debt incurred other than in the ordinary course of
business only upon court authorization after notice and hearing.
If the trustee is unable to obtain credit or incur debt even with the assurance that it will be treated
as an administrative expense, the court, after notice and hearing, may authorize additional
priority. A postpetition creditor could receive, as an additional priority over competing claims:
•
priority over any or all administrative expenses;
•
a lien on unencumbered assets of the estate; or,
•
a junior lien on property of the estate already subject to a lien.
If a trustee is unable to obtain credit otherwise, and can provide adequate protection to the interest
of a pre-existing lien holder, the court, after notice and hearing, may authorize the obtaining of
credit or the incurring of debt secured by a senior or equal lien on property of the estate that is
already subject to a lien. 11 U.S.C. § 364(a)-(d).
F. Executory Contract and Unexpired Leases
A trustee, subject to the court’s approval, may assume or reject an executory contract or
unexpired lease. This permits the bankruptcy estate to shed obligations which are burdensome
and impede the likelihood of a successful reorganization, or conversely, to retain advantageous
commitments which will benefit the estate and its creditors.
The Code does not define what constitutes an “executory contract,” but the legislative history
suggests that “it generally includes contracts on which performance remains due to some extent
on both sides.”47
47
H.Rept. 95-595, supra note 16 at 347.
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The trustee’s power to assume or reject a contract is conditioned. In order to assume, the trustee
must cure any default in the contract or lease (other than a default by virtue of filing in
bankruptcy) and provide adequate assurance of future performance if there has been a default.
Special forms of “adequate assurance” obtain with respect to shopping center leases when the
debtor is a lessee. The trustee is prohibited from assuming or assigning a contract or lease if
applicable nonbankruptcy law excuses the other party from performance to someone other than
the debtor, unless the other party consents.
The trustee must assume or reject within specified time frames. In a liquidation case, the trustee
must assume within 60 days (or within an additional 60 days if the court, for cause, extends the
time). If not, the contract is deemed rejected. In a reorganization case, the time limit is not fixed,
although a party to the contract may request the court to specify a time by which the trustee must
make a determination.
The Code invalidates bankruptcy clauses in executory contracts which purport to automatically
terminate the contract or lease in the event of bankruptcy. Likewise, the trustee may assign the
contract, notwithstanding a contrary provision within it, if assignment is permissible under
applicable nonbankruptcy law.
Special provisions govern unexpired leases of real property of the debtor in which the debtor is
the lessor, unexpired leases of personal property in which the debtor is lessee, timeshare interests
under a timeshare plan in which the debtor is the seller,48 contracts for the sale of property in
which the debtor is seller, executory contracts governing licensing agreements for intellectual
property under which the debtor is a licensor, and commitments by a debtor to maintain the
capital of an insured depository institution.
When a contract or lease is rejected by the debtor, the other party to the agreement may assert a
claim for damages arising from the breach. Such a claim is treated as a prepetition, unsecured
claim against the estate. Assumption of the contract is an act of administration of the estate, and
the expenses and liabilities connected therewith are high priority expenses of administration. 11
U.S.C. § 365.
G. Termination of a Debtor’s Utility Service
A utility may not discontinue service to or discriminate against the debtor solely on the basis of
the commencement of a case in bankruptcy, or because a debt owed to the utility was not paid
when due prior to the filing. The utility may discontinue service, however, if, within 20 days after
the order for relief, the debtor does not furnish adequate assurance of payment in the form of a
deposit, or other security, for service after that date. The court, after notice and hearing, may
adjust the amount of the deposit or other security necessary to provide adequate assurance. 11
U.S.C. § 366.
48
The rights of lessees and timeshare buyers as creditors were strengthened pursuant to amendments in § 205 of the
1994 Reform Act, supra note 25.
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IV. The Estate
A. Property of the Estate
The filing of a case under the Code creates a bankruptcy estate composed, in part, of the
following property, wherever located:
•
all legal or equitable interests of the debtor in property as of the commencement
of the case;
•
all interests of the debtor and spouse in community property under debtor
control; or liable for an allowable claim against the debtor, or against the debtor
and the debtor’s spouse, to the extent such interest is liable;
•
property interest received or recovered by the trustee from a custodian, an
avoided transfer, a setoff, or general partners in a partnership;
•
property acquired by the debtor within 180 days of the commencement of the
case—by bequest, devise, or inheritance; as a result of a property settlement
agreement or a divorce decree; or, as a beneficiary of a life insurance policy or
death benefit plan;
•
income from estate property, except income from earnings from services
performed by an individual debtor after commencement of the case; and
•
any property interest acquired by the estate after commencement of the case.
The estate does not include:
•
any power that the debtor may only exercise for the benefit of an entity other
than the debtor;
•
any interest of the debtor as a lessee under a lease of nonresidential real property
that has terminated under its terms before the filing in bankruptcy, or that expires
in the course of the bankruptcy;
•
eligibility of a debtor educational institution to participate in programs authorized
under the Higher Education Act, or any accreditation status or state licensure of
the debtor;
•
certain interests in oil and gas production payments;
•
certain interests in cash that constitute proceeds of a sale by the debtor of a
money order under an agreement with a money order issuer that prohibits the
commingling of such proceeds with property of the debtor; or
•
an interest in a spendthrift trust where the restriction on transfer is enforceable
under applicable nonbankruptcy law. 49
49
In Patterson v. Shumate, 112 S. Ct. 2242 (1992), the Supreme Court addressed a question which had divided the
courts of appeals and led to confusion and fragmentation in the bankruptcy administration of pensions qualified under
the Employee Retirement Income Security Act (ERISA). The Court held that ERISA-qualified pension plans are
excludable from a debtor’s estate. Hence, they are not available for distribution to creditors. In Yates v. Hendon, 124 S.
(continued...)
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With the exception of an enforceable spendthrift trust, other terms of agreements, transfer
instruments, or applicable nonbankruptcy laws that restrict or condition transfers of a debtor’s
interest in property, or that condition transfers on financial insolvency, will not prevent property
from coming within the bankruptcy estate. 11 U.S.C. § 541.
B. Turnover of Property of the Estate
When a case is commenced, anyone holding estate property—except a custodian50—that the
trustee may use, sell, or lease, or that the debtor may exempt from the estate (see infra), must
deliver it to the trustee and account for such property or its value.
Likewise, anyone owing a debt that is property of the estate and is matured, payable on demand
or order, must (except if it may be setoff against a claim against the debtor) pay it over to the
trustee. The court may order attorneys, accountants, other persons holding recorded information
(i.e., books, records, documents, and other papers related to the debtor’s financial affairs, etc.) to
disclose such information to the trustee.
There are specified exceptions to the turnover provisions. A life insurance company may continue
to make automatic premium loans from property that may otherwise be property of the estate.
And, an entity having no actual notice or knowledge of the commencement of a case by the
debtor may transfer estate property, or pay a debt owing to the debtor, to a person other than the
trustee, with the same effect as if the debtor had not commenced the case. 11 U.S.C. § 542.
C. Turnover of Property by a Custodian
When a custodian of the debtor’s property becomes aware of the commencement of a case by or
against the debtor, he is prohibited from making any disbursement thereafter, or taking any action
(other than an action to preserve the property) in the administration of the property in his custody
and is further required to turn over such property, or proceeds thereof, to the trustee, and to file an
accounting of his custodianship.
The bankruptcy court must protect all entities to which the custodian became obligated with
respect to such property; provide reasonable compensation to the custodian for services rendered;
and, surcharge a custodian for improper or excessive disbursements, unless they were approved
by a court or were made in accordance with applicable law. The bankruptcy court may, however,
excuse compliance with these requirements if the interests of creditors and equity security holders
(...continued)
Ct. 1330 (2004), the Court held that a sole shareholder and president of a professional corporation could qualify as a
“participant” in an ERISA pension plan sponsored by his corporation, as long as the plan covers one or more
employees other than the working owner.
50
A “custodian” means—
(A) receiver or trustee of any of the property of the debtor, appointed in a case or proceeding not
under the Code;
(B) assignee under a general assignment for the benefit of the debtor’s creditors; or
(C) trustee, receiver, or agent under applicable law, or under a contract, that is appointed or
authorized to take charge of property of the debtor for the purpose of enforcing a lien against such
property, or for the purpose of general administration of such property for the benefit of the
debtor’s creditors. 11 U.S.C. § 101(11).
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would be better served by permitting a custodian to continue in possession of the property. 11
U.S.C. § 543.
D. The Trustee’s Avoidance Powers
Many provisions in the Bankruptcy Code permit the trustee to nullify or “avoid” prepetition
transfers from the debtor to others, including certain liens. The purpose of requiring creditors in
specified situations to disgorge monies received from the debtor prior to the bankruptcy is to
maximize the bankruptcy estate to ensure equitable distribution among all creditors. Constraints
on the trustee’s avoidance powers are necessary to protect normal commercial transactions.
Although the provisions governing avoidance are extremely complex, they are surveyed below.
1. Trustee as Lien Creditor and as Successor to Certain Creditors and
Purchasers
As of the commencement of the case, and without regard to knowledge of the trustee or any
creditors, and regardless of whether such creditor or purchaser exists, the trustee has the rights
and powers of, or may avoid any property transfer or obligation of the debtor that is voidable by:
•
a creditor on a simple contract with a judicial lien on the property;
•
a creditor with an unsatisfied writ of execution against property of the debtor;
•
bona fide purchasers of debtor’s property; and
•
an unsecured creditor under applicable law.
This provision is known as the Bankruptcy Code’s “strong arm clause.”51 It permits the trustee to
assume the attributes of specified hypothetical creditors or bona fide purchasers who, under
applicable nonbankruptcy law, would be afforded priority in the interest that the trustee seeks to
avoid. 11 U.S.C. § 544.
2. Statutory Liens
The trustee may avoid the fixing of a statutory lien to the extent that such lien:
(a) first becomes effective against the debtor when—
51
•
a bankruptcy (or other insolvency proceeding not under the Code) is commenced,
•
a custodian is appointed,
•
the debtor becomes insolvent,
•
the debtor’s financial condition fails to meet a specified standard, or
•
an entity other than a statutory lien holder levies execution against the debtor’s
property;
H.Rept. 95-595, supra note 16 at 370; Sen. Rep. 95-989, supra note 16 at 85.
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(b) is not perfected or enforced against a bona fide purchaser on the date the case commences,
whether the purchaser exists or not;
(c) is for rent; or
(d) is a lien for distress of rent.
Many of the above-described liens are created under state law to establish priorities for
distribution consistent with state plans for insolvency. These priorities have not been incorporated
into the federal scheme embodied in the Code. 11 U.S.C. § 545.
3. Limitations on Avoiding Power
The trustee’s rights and powers under certain of the avoiding powers are limited.
The use of such power with respect to statutory liens, preferences, fraudulent transfers and
obligations, and as a lien creditor, is subject to a general statutory limitation of the later of two (2)
years after the case is filed or one (1) year after the first trustee’s appointment under chapter 7, 11,
12, or 13, if this occurs before the case is closed or dismissed, whichever occurs first.
If, under generally applicable law as of the date of the filing of the petition, an interest holder
against whom the trustee would have rights (as a lien creditor, or with respect to statutory liens
and post-petition transactions) still has the opportunity to perfect, or to maintain or continue
perfection of, his lien against an intervening interest holder, then he may perfect his interest
against the trustee. If the generally applicable law requires seizure of the property to accomplish
perfection and the property has not been seized, then perfection is by notice to the trustee instead.
The trustee may not avoid the seller’s right of reclamation if the right asserted was created by
statute or common law; the debtor received the goods while insolvent; and, the seller made
written demand for reclamation within 10 days after debtor’s receipt of the goods (or, if the 10
days expire after the commencement of the case, before 20 days after receipt of such goods by the
debtor).
In a chapter 11 case, the court may, on motion, permit the trustee to return goods shipped to the
debtor by the creditor before the commencement of the case, and the creditor may offset the
purchase price of such goods against any prepetition claim of the creditor.
The Code places additional restraints upon a trustee’s avoiding powers when the debtor operates
specified businesses, e.g., grain storage facility, fish processing facility, commodity broker,
forward contract merchant, stockbroker, swap agreement participants, financial institution or
securities clearing agency. 11 U.S.C. § 546.
4. Preferences
A “preference,” in essence, is a prebankruptcy transaction which has the effect of favoring one
creditor over others.52 In the absence of the Code’s provisions which permit a trustee to avoid
52
“A preference is a transfer that enables a creditor to receive payment of a greater percentage of his claim against the
debtor than he would have received if the transfer had not been made and he had participated in the distribution of the
(continued...)
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such transactions, preferences—like other avoidable transfers—might otherwise be perfectly
valid transactions. In order to facilitate the Code policy of “equality of distribution,” the trustee
may avoid a transfer of property of the debtor if it (1) was made for the benefit of a creditor, (2)
on account of an antecedent debt, (3) while the debtor was insolvent, (4) within 90 days before
the date of the filing of the petition53 or between 90 days and one year before the filing of the
petition if the creditor was an insider, and (5) enables the creditor to receive more than he would
otherwise receive if the debtor’s estate were in liquidation or were otherwise distributed under the
Code.
Among the transactions that are excluded from attack as a preference and which the trustee may
not avoid are:
•
a transfer which is intended to be and is in fact a contemporaneous exchange for
new value (money or money’s worth in goods, services, or new credit) given to
the debtor;
•
a transfer made according to ordinary business terms in payment of a debt
incurred by the debtor in the ordinary course of business or financial affairs of
the debtor and the transferee;54
•
a transfer that creates a security interest securing new value in property acquired
by the debtor that meets specified conditions and is perfected on or before 20
days after the debtor receives possession of the property;
•
a transfer to or for the benefit of a creditor, to the extent that, after such transfer,
the creditor gave “new value” to or for the benefit of the debtor and such “new
value” is not secured by an otherwise unavoidable security interest; and on
account of which the debtor did not make an otherwise unavoidable transfer to
the creditor;
•
a transfer that creates a perfected security interest in inventory or a receivable or
the proceeds of either, except to the extent that the aggregate of all such transfers
to the transferee caused a reduction, as of the date of filing of the petition and to
the prejudice of other creditors holding unsecured claims, of any amount by
which the debt secured by such security interest exceeded the value of all
security interests for such debt on the later of specified dates;
•
a transfer that is the fixing of a statutory lien that is not avoidable under the
Code;
(...continued)
assets of the bankrupt estate. The purpose of the preference section [11 U.S.C. § 547] is two-fold. First, by permitting
the trustee to avoid prebankruptcy transfers that occur within a short period before bankruptcy, creditors are
discouraged from racing to the courthouse to dismember the debtor during his slide into bankruptcy. The protection
thus afforded the debtor often enables him to work his way out of a difficult financial situation through cooperation
with all of his creditors. Second, and more important, the preference provisions facilitate the prime bankruptcy policy
of equality of distribution among creditors of the debtor. Any creditor that received a greater payment than others of his
class is required to disgorge so that all may share equally.” H.Rept. 95-595, supra note 16 at 177-78.
53
For the purposes of calculating time, a transfer made by check is deemed to occur on the date the check is honored by
the drawee bank, not the date when it is presented to the creditor. Barnhill v. Johnson, 111 S. Ct. 2150 (1992).
54
Payments on long-term debt, as well as those on short-term debt, may qualify for the ordinary course of business
exception. This interpretation of the statute, established in Union Bank v. Wolas, 112 S. Ct. 527 (1991), overruled a
large body of case law holding to the contrary.
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•
a transfer which is a bona fide payment to a spouse or former spouse for alimony,
maintenance or child support; or
•
a transfer in a case filed by an individual debtor whose debts are primarily
consumer debts, if the aggregate value of all property that constitutes or is
affected by such transfer is less than $600.
The trustee has the burden of proving the avoidability of a transfer which is generally avoidable
under this section, while the creditor or party in interest against whom recovery is sought has the
burden of proving that the transfer is nonavoidable. 11 U.S.C. § 547.
5. Fraudulent Transfers and Obligations
Fraudulent transfers and obligations basically fall in two categories—those made with intent to
hinder, delay or defraud creditors, and those made while the debtor is insolvent (or which render
the debtor insolvent) where the exchange is for less than reasonably equivalent value.55
The trustee may avoid any transfer or obligation incurred by the debtor within one year prior to
the commencement of the case if the debtor voluntarily or involuntarily:
•
made such transfer or incurred such obligation with actual intent to hinder, delay,
or defraud an existing or future creditor;
•
received less than a reasonably equivalent value in exchange for such transfer
and obligation and (a) was insolvent on the date of such transfer or obligation; (b)
was, or was about to engage in business or a transaction for which his remaining
property was an unreasonably small capital; or, (c) intended to incur, or believed
the debtor would incur debts beyond his ability to repay at maturity.
The trustee of a partnership debtor may avoid transfers and obligations incurred by the debtor,
within one year prior to commencement of the case to a general partner in the debtor if the debtor
was insolvent on the date of such transfer, or was made so because of it.
However, so long as a transfer voidable under any of the above is not also voidable by the trustee
as a lien creditor, or as a voidable statutory lien or preference, then a transferee or obligee who
takes for value and in good faith (i.e. absence of actual intent to defraud) has a lien on the interest
transferred, may retain the lien transferred, or may enforce any obligation incurred, to the extent
of the value furnished by the transferee or obligee to the debtor.
This section was amended in 1998 to expressly provide that prepetition contributions of up to 15
percent of a debtor’s gross annual income—or more than 15 percent if the contribution is
consistent with the debtor’s past practice—to qualified religious or charitable organizations may
55
In a case under the act of 1898 analyzing the avoidability of exchanges for less than reasonably equivalent value, the
United States Court of Appeals for the Fifth Circuit found that the sale of a home at foreclosure for approximately 57.7
percent of its fair market value was not reasonably equivalent and was voidable in bankruptcy by the debtor in
possession. Durrett v. Washington National Insurance Co., 621 F.2d 201 (5th Cir. 1980). In 1994, the U.S. Supreme
Court, in BFP v. Resolution Trust Corp., 114 S. Ct. 1757, overruled Durrett and resolved a split among the circuit
courts by holding that a “reasonably equivalent value” for foreclosed real property is the price in fact received at the
foreclosure sale, so long as all the requirements of state foreclosure law have been complied with.
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not be avoided. Reference is made to the Internal Revenue Code of 1986 for definitions of
“charitable contribution” and “qualified religious or charitable” organizations.
6. Postpetition Transactions
As of the commencement of a case—which is usually synonymous with the filing of the
petition—the property of the debtor becomes property of the estate. Generally, the trustee may
avoid transfers that occur after the filing of the petition which are not expressly authorized by
either the Code, without court order, or the court.
In an involuntary case, the trustee may not avoid certain “involuntary gap” transactions, i.e., those
which occur between the filing of the petition and the entering of an order for relief, in which the
transferee has given new value for the transfer.
Likewise, the trustee may not avoid a transfer of real property to a good faith purchaser if the real
property is located outside the county where the case is commenced; if a present, fair equivalent
value is paid for the property; if the purchaser does not know of the commencement of the case,
and, if a copy of the petition has not been filed in the proper county office for recording real
property conveyances before the transfer is perfected against a bona fide purchaser.
Proceedings by a trustee to avoid postpetition transactions may not be commenced after the
earlier of two years after the date of transfer or the time the case is closed or dismissed. 11 U.S.C.
§ 549.
7. Liability of Transferee of Avoided Transfer
When the trustee seeks to avoid a transfer pursuant to the Code, the trustee may recover the
property transferred, or, if the court orders, the value of such property not only from the initial
transferee, but from others who may have received the property, i.e., any immediate or mediate
transferee of the initial transferee. The trustee may not, unless the specific avoidance statute
provides otherwise, recover from an immediate or mediate transferee who takes for value without
knowledge of the avoidability of the transfer, or who accepts the transfer in good faith.
If a transfer is an avoidable transfer because it was made within 90 days to one year before the
filing of the petition; is avoidable under section 547(b); and was made for the benefit of a creditor
who at the time of the transfer was an insider, then the trustee may not recover under this section
from a transferee that is not an insider.
When the trustee may recover property from a good faith transferee, the latter retains a lien on the
property recovered to secure the lesser of (a) the cost, to such transferee of any improvement
made after the transfer, less the amount of any profit realized by the transferee, and (b) any
increase in the value of the property as a result of improvements.
A proceeding against a subsequent transferee must be brought by the earlier of either one year
after the avoidance of the transfer on account of which the recovery is sought or the time the case
is closed or dismissed. 11 U.S.C. § 550.
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E. Postpetition Effect of Security Interest
Under Article 9 of the Uniform Commercial Code, creditors may take security interests in afteracquired property. The Bankruptcy Code, however, governs the effect of such a security interest
in postpetition property. As a general rule, if a security agreement is entered into before the
commencement of the case, then property acquired by the estate is not subject to the security
interest created by a provision in the security agreement extending the security interest to afteracquired property of the debtor.
When the security agreement, by its terms, extends to property acquired by the debtor before
commencement of the case and to proceeds, products, offspring, rents or profits of such property,
then the security interest may survive the bankruptcy filing to encompass the after-acquired
property to the extent provided in the security agreement and by applicable nonbankruptcy law,
except as the court, after notice and hearing, may otherwise provide based on the equities of the
case.
The Code specifies that a prepetition security agreement for property paid as rents or charges for
the use or occupancy of hotel or motel rooms may be treated as encumbered after-acquired
property. 56 11 U.S.C. § 552.
F. Setoff
A setoff occurs when there are two debts which arise out of separate transactions, one owed from
the debtor and one owed to the debtor, and the party who owes the debt to the debtor reduces the
debt to account for that which the debtor owes. Although a setoff may appear to be the type of
transaction which is avoidable by a trustee, the Code generally permits it.
Subject to two exceptions and three general restrictions or prohibitions, the Code does not affect a
creditor’s right under applicable nonbankruptcy law to offset prepetition debts owing by him to
the debtor. The exceptions to the right of setoff are the automatic stay and the right of the trustee
to use, sell, or lease estate property that is subject to a right of setoff. Offset is not allowed
•
if the creditor’s claim is not allowed;
•
if the claim was transferred to the creditor by someone other than the debtor after
commencement of the case, or after 90 days before the commencement of the
case, and while the debtor was insolvent.
•
if the debt owed to the debtor by the creditor was incurred by the creditor after 90
days before the commencement of the case, while the debtor was insolvent, and
for the purpose of obtaining a right of setoff against the debtor.
Subject to certain exceptions, when an offset occurs prior to the commencement of a case, the
trustee may recover the setoff to the extent that any “insufficiency”, i.e., any amount by which a
claim against the debtor exceeds a mutual debt owing to the debtor by the holder of such claim,
exists on the later of 90 days before commencing the case, or the first date during such 90 days on
which there is an insufficiency. 11 U.S.C. § 553.
56
The provision addressing proceeds of hotel and motel receipts was added by § 214 of the 1994 Reform Act and was
intended to resolve fragmented case law addressing the issue.
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G. Abandonment of Property of the Estate
After notice and hearing, the trustee may abandon any property of the estate that is burdensome to
the estate or that is of inconsequential value to the estate.57 A party in interest may request the
court to order the trustee to abandon any property of the estate that is burdensome. 11 U.S.C. §
554.
V. Creditors and Claims
A. Filing of Proofs of Claims
A creditor or an indenture trustee may file a proof of claim. An equity security holder may file a
proof of interest. 11 U.S.C. § 501. This requirement is permissive only, and does not require filing
of a proof of claim by any creditor. The debtor is generally responsible for filing a schedule of
debt and creditors. However, when a debt is incorrectly listed, or when a creditor with a lien is
undersecured and asserts a claim for the balance of the debt owed him, this section facilitates
filing.
If a creditor fails to file a claim, then the debtor, trustee, or anyone who is liable to the creditor
with the debtor (i.e., a codebtor, surety, guarantor, etc.) may file a proof of claim.
All unsecured creditors, except those holding claims entitled to administrative priority, and equity
security holders must file a proof of claim if they wish to be eligible to receive a distribution
under chapters 7 and 13. In a chapter 11 case, the debtor’s schedule of liabilities is adequate
unless the creditor takes issue with the amount of the claim, or unless it is not listed, or is listed as
disputed, contingent or unliquidated. In a chapter 7 liquidation or chapter 13 reorganization, the
proof of claim must be filed by nongovernmental creditors within 90 days after the first date set
for the meeting of creditors; in chapter 11 reorganizations, the court sets the date for filing proofs
of claim. Bankruptcy Rules 3002, 3003.
B. Allowance of Claims or Interests
When proof of a claim or interest is properly filed, it is deemed allowed unless a party in interest
objects. After notice and a hearing, the amount of a disputed claim is determined by the court.
The Code expressly disallows many types of claims. Among those which are disallowed is a
claim which:
•
is unenforceable against the debtor or his property for any reason other than
because it is contingent or unmatured;
•
is for unmatured interest;
57
A trustee may not abandon property in contravention of state laws reasonably designed to protect the public health
and safety. Hence, a chapter 7 debtor would not be permitted to abandon a toxic, PCB- contaminated oil storage facility
in violation of state and federal environmental law. Midlantic National Bank v. New Jersey Department of
Environmental Protection, 474 U.S. 494 (1986).
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•
is a property tax claim and the amount due exceeds the value of the estate’s
interest in the property;
•
is for the services of an insider or attorney and exceeds the reasonable value of
such services;
•
is an unmatured and nondischargeable claim for alimony, maintenance or support
to a spouse and children under a divorce decree, separation agreement, or
property settlement agreement;
•
is a damage claim arising out of a lease termination and, without acceleration, it
exceeds the greater of the reserved rental for one year, or fifteen percent, not to
exceed three years, of the remaining lease term following the earlier of the date
of filing and the date of repossession or surrender of the property, plus the unpaid
rent due, without acceleration, under the lease;
•
is for damages by an employee arising out of termination of an employment
contract which exceed one year’s compensation plus any unpaid compensation
due under the contract;
•
results from a reduction, due to late payment, of an otherwise applicable credit
available to the debtor in connection with an employment tax on wages, salaries
or commissions earned from the debtor;
•
proof of such claim is not timely filed, except as authorized elsewhere in the
Code or Bankruptcy Rules, except that the claim of a government unit is timely if
it is filed within 180 days after the order for relief;
•
is a claim of a claimant who has received a voidable transfer unless the claimant
has paid the amount or turned over the property received.
Contingent and unliquidated claims which cannot be fixed or liquidated without delaying the
administration of the case may be estimated. 58
Certain types of claims which may be allowed or disallowed are treated as prepetition claims
even though they may arise after the filing of the petition. These include claims arising in the
ordinary course of the debtor’s business after the commencement of the case but before the order
for relief is entered in an involuntary case; claims arising from the rejection of an executory
contract or unexpired lease; and specified claims concerning the recovery of property and taxes.
A claim that has been allowed or disallowed may be reconsidered for cause. 11 U.S.C. § 502.
C. Allowance for Administrative Expenses
Claimants may file a request for payment of an administrative expense. Administrative expenses
are extremely important because they are “high priority claims” which are paid first out of the
debtor’s assets. They may be paid prior to or upon confirmation of a reorganization plan, or upon
58
The estimation of personal injury claims for purposes of determining the feasibility of reorganization is often
undertaken in chapter 11 cases involving mass tort liability. See, e.g, A.H. Robins Co., Inc. v. Piccinin, 788 F.2d 994,
1011-1014 (4th Cir. 1986); In Re UNR Industries, Inc., 45 B.R. 322, 326-27 (N.D. Ill. 1984).
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distribution of the estate’s assets in a liquidation. Payment of administrative expenses requires
notice and hearing. Allowable administrative expenses include:
•
the actual, necessary costs and expenses of preserving the estate, including
wages, salaries, or commissions for services rendered after the commencement of
the case;
•
certain taxes incurred by the estate, e.g., taxes attributable to an excessive
allowance of a tentative carryback adjustment that the estate received, whether
the taxable year to which the adjustment related ended before or after the
commencement of the case, including any fine, penalty, or reduction in credit
relating to taxes entitled to administrative relief;
•
compensation and reimbursement of trustees, examiners, and professional
persons employed by the estate. Persons rendering professional services must
obtain court approval;
•
actual necessary expenses of a creditor who, after court approval, recovers
property for the benefit of the estate; prosecutes a criminal offense relating to the
case, or to the debtor’s property or business; parties, including certain creditors’
committees, who make a substantial contribution in a case under chapter 9 or 11;
and, the actual and necessary expenses of a chapter 11 committee member and
those of a superseded custodian;
•
reasonable compensation for professional services rendered by an accountant or
attorney, and their actual, necessary expenses;
•
reasonable compensation of an indenture trustee; and
•
certain fees and mileage.
11 U.S.C. § 503.
D. Sharing of Compensation
With two exceptions, the sharing of compensation (i.e. fee splitting) among trustees, examiners,
professionals, attorneys and accountants is prohibited. Partners and associates in the same
professional association are excepted, as are attorneys for petitioning creditors that join in a
petition commencing an involuntary case. 11 U.S.C. § 504.
E. Determination of Tax Liability
The court may determine the amount or legality of any tax, any fine, or any penalty relating to
tax, whether or not previously assessed, paid, or contested. The bankruptcy court may not make
such a determination with respect to taxes when the issues have been adjudicated by an
administrative or judicial tribunal before the commencement of the case.
Nor may the court determine the right of the estate to a tax refund unless at least 120 days have
passed since the trustee properly requested such refund, or, after such time, the governmental unit
has not made a determination with respect to the refund request.
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The trustee may request a determination of any unpaid tax liability of the estate incurred during
the administration of the case by submitting a tax return and a request for such a determination to
the government. Upon payment of the tax due, or, unless the government notifies the trustee of its
intent to examine the return and actually does so within specified time frames, the trustee and
debtor will be discharged from any liability with respect to such tax. 11 U.S.C. § 505.
F. Determination of Secured Status
The Code distinguishes secured from unsecured claims. A secured creditor is secured only to the
extent of the value of the property securing the creditor’s claim. To the extent that a lien secures a
claim that is not allowed, it is void. The distinction between secured and unsecured is particularly
import to the undersecured creditor, i.e., a creditor whose secured collateral is worth less than the
amount of his claim. An undersecured creditor’s claim is bifurcated—it is an allowed secured
claim to the extent of the value of the collateral, and an unsecured claim for the balance of the
allowed claim. 59 The same treatment applies to a creditor who has a right to offset a mutual debt
owing to the debtor, i.e., he will have an allowed secured claim to the extent of the setoff and an
allowed unsecured claim for the balance.
An oversecured creditor, that is, one whose collateral is worth more than the amount of the claim,
will be allowed to receive interest on his claim and reasonable fees (including attorney fees),
costs, or other charges provided under the agreement which is the basis for the claim. The trustee,
however, may recover from the collateral the reasonable and necessary costs of preserving or
disposing of such property to the extent that any benefit inures to the creditor. 11 U.S.C. § 506.
G. Priorities in Distribution
The Code establishes priorities for the distribution of unsecured claims which may be divided into
two categories—priority and nonpriority. Nonpriority unsecured claims will be paid only after
payment of priority claims. Unfortunately, there is often little left in a bankruptcy estate for
distribution to nonpriority unsecured creditors who may therefore receive only a scant percentage
of the amount due. Although these priorities may be more important in a liquidation, or in
reorganizations when a debtor’s business ceases to operate, a reorganization plan must provide for
unsecured creditors in ways consistent with the distributions contemplated under the statute.60
•
First priority is accorded to administrative expenses of the estate;
•
Second priority goes to “involuntary gap” creditors, i.e., creditors whose claims
arise in the ordinary course of the debtor’s business or financial affairs after the
filing of an involuntary petition but before either a trustee is appointed or an
order for relief is entered;
59
In Dewsnup v. Timm, 112 S. Ct. 773 (1992), the U.S. Supreme Court held that § 506(d) which voids any lien to the
extent it is not an “allowed secured claim,” cannot be used by a chapter 7 debtor to “strip down” an undersecured
creditor’s mortgage lien to the judicially determined value of the collateral, even though § 506(a) states that an
“allowed claim” is “secured” only to the extent of the collateral’s value.
60
Pursuant to amendments effected by the 1994 Reform Act, monetary amounts for priorities will be adjusted
automatically at three-year intervals to reflect changes in the Consumer Price Index. 11 U.S.C. § 104(b).
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•
Third priority is designated for unsecured claims for wages, salaries, or
commissions, but only to the extent of $4925 for each individual, including
vacation, severance and sick leave pay earned by an individual or corporation
within 90 days before the date of filing or the date of the cessation of the debtor’s
business, whichever occurs first; or, for sales commissions earned by an
individual or by a corporation with only one employee acting as an independent
contractor in the sale of goods or services for the debtor;61
•
Fourth priority is similar to the third but governs unsecured claims for
contributions to an employee benefit plan arising from services rendered within
180 days before the filing or cessation of the debtor’s business, but only to the
extent of the number of employees covered by each such plan multiplied by
$4925 less the aggregate amount paid to such employees under the third priority,
plus the aggregate amount paid by the estate on behalf of such employees to any
other employee benefit plan;
•
Fifth priority goes to the unsecured claims of persons engaged in the production
or raising of grain against a debtor who owns or operates a grain storage facility,
and of persons engaged as a United States fisherman against a debtor who
operates a fish produce storage or processing facility, but only to the extent of
$4925 for each such individual;
•
Sixth priority is for allowed unsecured claims of individuals, to the extent of
$2225 for each individual, arising from the deposit, before the commencement of
the case, of money for the purchase, lease or rental of property, or the purchase of
services for personal, family or household use that were not delivered or
provided;
•
Seventh priority—with no monetary limits—was added in 1994 and goes to
allowed claims for debts to a spouse, former spouse, or child of the debtor, for
alimony or support, in connection with a separation agreement, divorce decree, or
property settlement;62
•
Eighth priority addresses unsecured claims by governmental units for a wide
range of taxes, including income taxes, property taxes, withholding taxes,
employment taxes, excise taxes,63 customs duties, and an erroneous tax refund or
credit; and
61
Priority for sales commissions of independent contractors was added by § 207 of the 1994 Reform Act. The
contractor must have made the sales in the ordinary course of the debtor’s business and must have earned 75% of total
earnings in the year preceding the filing in sales of the debtor’s goods or services.
62
Section 304 of the 1994 Reform Act makes widespread amendments raising the level of protection in bankruptcy
accorded to alimony and support payments. See also, 11 U.S.C. §§ 362, 522, 523, and 547 governing automatic stays,
exemptions, dischargeability and avoidable transactions.
63
A provision in the Internal Revenue Code, 26 U.S.C. § 4971(a), imposes a 10 percent “tax” on an accumulated
funding deficiency from an annual contribution to specified pension plans. The Government filed a proof of claim for
tax liability, arguing that it was entitled to priority as an “excise tax.” The U.S. Supreme Court held that the claim was
not entitled to priority as an “excise tax” despite the fact that it was so characterized under the Internal Revenue Code.
For bankruptcy purposes, the claim constituted a penalty to be dealt with as an ordinary, unsecured claim. Hence, the
Court will examine whether a particular exaction called a “tax” in the statute creating it is also one for bankruptcy
purposes. United States v. Reorganized CR&I Fabricators of Utah, 116 S. Ct. 2106 (1996).
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•
Ninth priority—with no monetary limits—is for allowed unsecured claims based
upon a commitment by the debtor to a Federal depository institutions regulatory
agency to maintain the capital of an insured depository institution.
With respect to secured creditors, the Code grants a “super” priority to creditors for losses
incurred by a secured creditor arising when it is determined that he received inadequate protection
of his interests during the automatic stay, or in the trustee’s use, sale or lease of estate property,
and in credit transactions with a trustee authorized to operate a debtor’s business. 11 U.S.C. §
507.
An additional “super” priority exists for administrative expenses incurred after conversion of a
chapter 11, 12, or 13 case to a chapter 7 liquidation. 11 U.S.C. § 726(b).
H. Claims of Codebtors; Subordination
A codebtor (i.e., surety, guarantor, or co-maker) who pays a claim is subrogated to the rights of
the creditor to the extent of the payment. The court is required to subordinate the claim of a surety
or codebtor of an obligation to a creditor of the estate, unless the creditor has been paid in full. 11
U.S.C. § 509.
A subordination agreement is enforceable in bankruptcy to the same extent that such agreement is
enforceable under applicable nonbankruptcy law. The Code also recognizes principles of
equitable subordination, which generally hold that a claim
or interest may be subordinated only if its holder is guilty of inequitable conduct. The bankruptcy
court makes a determination of equitable subordination on a case-by-case basis.64 11 U.S.C. §
510.
VI. The Debtor’s Duties and Benefits
A. Basic Duties
The Code specifies five duties of the debtor that pertain to all cases. Although it is by no means
exhaustive of all of the debtor’s responsibilities in bankruptcy, the debtor must:
•
file a list of creditors with the court, and, unless the court orders otherwise, a
schedule of assets and liabilities and a statement of the debtor’s financial affairs;
•
if the debtor’s debts include consumer debts which are secured by property of the
estate and a petition is filed under chapter 7, the debtor must file a statement of
his intention to retain or surrender the property and, if applicable, specify
64
Overruling a court of appeals’ finding that postpetition, nonpecuniary loss tax penalty claims are “‘susceptible to
subordination’ by their very ‘nature[,]’” the U.S. Supreme Court held that “Congress could have, but did not, deny
noncompensatory, postpetition tax penalties the first priority given to other administrative expenses, and bankruptcy
courts may not take it upon themselves to make that categorical determination under the guise of equitable
subordination.” United States v. Noland, 116 S. Ct. 1524 (1996). See also, United States v. Reorganized CF&I
Fabricators of Utah, 116 S. Ct. 2106 (1996).
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property that is claimed as exempt, property that he intends to redeem, or debts
that he intends to reaffirm;
•
cooperate with the trustee, if one is serving;
•
surrender to the trustee all estate property and any recorded information (i.e.
books, papers, records, documents relating to estate property); and
•
appear at any hearing on discharge.
11 U.S.C. § 521.
B. Exemptions; Waiver of Exemptions
A legal treatise observes that “[f]ew people would voluntarily take any legal action which meant
the surrender of so much of their possessions as to leave them destitute and virtually helpless.”65
Hence, when an individual debtor’s assets are liquidated, the law permits him or her to retain a
certain minimum of money and property necessary to realize a “fresh start.”
Although it would be within Congress’ authority to establish a uniform set of bankruptcy
exemptions which would be binding upon the states by virtue of the Supremacy Clause, the Code
does not do so. For policy considerations, including deference to states’ rights, Congress permits
not just that the debtor make an election between federal and state created exemptions,66 but
permits the states to deny debtors the use of federal exemptions as well. Consequently, even
though there is a significant variance between the states in the generosity of their exemptions,
more than half have enacted laws that deny debtors the use of federal exemptions. 67
When the debtor’s state of domicile has not enacted legislation which precludes a debtor from
electing federal exemptions, the following are available:68
65
•
the debtor’s aggregate interest, not to exceed $18,450, in real or personal
property that the debtor uses as a residence, or in a burial plot for the debtor or a
dependent;
•
the debtor’s interest, not to exceed $2,950, in a motor vehicle;
•
the debtor’s interest, not to exceed $475, in any one item or $9,850 in aggregate
value, in household furnishings, household goods, wearing apparel, appliances,
books, animals, crops, or musical instruments, that are held for personal or family
use of the debtor;
•
the debtor’s aggregate interest, not to exceed $1,225, in jewelry held primarily
for the personal use of the debtor;
2 Cowans Bankr. Law and Practice § 8.1 (6th Ed. 1994).
66
In joint cases, or in individual cases where the estates of a husband and wife are administered jointly, debtors may
elect either state or federal exemptions—if the latter are permitted in the debtors’ state—but one debtor may not elect
state exemptions and another elect federal. This practice, known as “stacking” exemptions, was stopped pursuant to
1984 amendments to 11 U.S.C. § 522(b).
67
2 Cowans, supra at § 8.2.
68
Pursuant to amendments effected by the 1994 Reform Act, monetary amounts for exemptions will be adjusted
automatically at three-year intervals to reflect the change in the Consumer Price Index. 11 U.S.C. § 104(b).
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•
the debtor’s aggregate interest in any property, not to exceed $975, plus up to
$9,250 of any unused amount of the exemption for housing above;
•
the debtor’s aggregate interest, not to exceed $1,850, in any implement,
professional books, or tools of the trade of the debtor;
•
any unmatured life insurance contract owned by the debtor;
•
the debtor’s aggregate interest, not to exceed $9,850, in any accrued dividend
under, or loan value of, any unmatured life insurance contract under which the
insured is the debtor;
•
professionally prescribed health aids;
•
the debtor’s right to receive social security benefits, unemployment
compensation, public assistance benefits, veterans’ benefits, disability, illness or
unemployment benefits, alimony and support to the extent reasonably necessary;
•
benefits under certain pension, profit sharing, stock bonuses, annuity or similar
plan or contract, to the extent necessary for the support of the debtor;
•
the debtor’s right to receive property traceable to an award under a crime victim’s
reparation law; a payment on account of a wrongful death of an individual of
whom the debtor was a dependent, to the extent reasonably necessary for the
support of the debtor; a personal injury award not exceeding $18,450 for actual
compensation (not including pain and suffering); and, payment in compensation
for loss of future earnings, to the extent reasonably necessary for support.
In states where federal elections are not permitted, the debtor would be limited to his exemptions
under applicable state and nonbankruptcy federal statutes. 69 In addition, property held by the
debtor which would be exempt from process under applicable state nonbankruptcy law, including
property held as a tenant by the entirety or joint tenant, may be exemptible.
Exempt property is exempt from all prepetition claims, including nondischargeable ones, with
specified exceptions. They include debts for certain nondischargeable taxes, alimony,
maintenance and child support, debts secured by certain nonavoidable liens, and specified debts
owned by a financial institution-affiliated party to a federal depository institutions regulatory
agency.
A debtor may be permitted to avoid certain judicial and nonpossessory, nonpurchase money liens
which might otherwise impair a claim to exemptible property. These are liens created by the
courts or by the debtor’s consent which encumber property of the debtor that would be
exemptible in bankruptcy but for the subject lien. 70
69
Examples of federal nonbankruptcy exemptions include veterans’ pensions, life insurance and disability benefits, 38
U.S.C. § 3101(a); Social Security benefits, 42 U.S.C. § 407; Federal Civil Service disability, death, and retirement
benefits, 5 U.S.C. §§ 8130, 8346(a); Military Survivor Benefit Plan Annuities, 10 U.S.C. § 1450(i); and, Servicemen
and Veteran’s group life insurance benefits, 38 U.S.C. § 770(g).
70
Section 303 of the 1994 Reform Act, supra note 25, prohibits the debtor from avoiding a judicial lien in connection
with a separation agreement or divorce decree that secures a debt to a spouse, former spouse, or child of the debtor for
alimony, maintenance or child support.
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In 1991, the Supreme Court held that judicial liens can be eliminated in bankruptcy even though a
state has defined exempt property in such a way as to specifically exclude property encumbered
by a judicial or nonpossessory, nonpurchase money lien.71 In other words, even if state law
honored the encumbrance against property which would ordinarily be exemptible, the debtor
nonetheless may avoid the subject liens. The 1994 amendments to the Code carve out a limited
exception to this principle. In cases where the debtor is limited to, or has chosen, state law
exemptions, if state law honors judicial or consensual liens on certain property that might
otherwise be claimed as exempt, namely, implements, professional books, or tools of the trade,
the debtor may not avoid the security interest to the extent that the value of such property is in
excess of $5,000.
A lien is considered to “impair” an exemption to the extent that the sum of the lien, all other liens
on the property, and the amount of the exemption that the debtor could claim if there were no
liens on the property exceeds the value that the debtor’s interest in the property would have in the
absence of any liens.
Waiver. A debtor’s waiver of an exemption in favor of an unsecured claim is unenforceable. Since
a debtor is permitted to exempt property recovered by the trustee pursuant to his avoiding power,
or recovered pursuant to a setoff, a waiver of those rights against property which may otherwise
be exempted may also be unenforceable. 11 U.S.C. § 522.
C. Discharge
A “discharge” in bankruptcy affords the debtor a “fresh start.” If a discharge is granted, the
debtor’s obligation to pay prepetition debt is extinguished. The manner of obtaining a discharge,
and its effect, varies between individuals and businesses. The Code specifies what types of debt
are dischargeable and nondischargeable, and the latter category includes many debts which the
court will examine and decide upon on a case-by-case basis. A discharge voids any judgment to
the extent that it is a determination of the personal liability of the debtor with respect to a
prepetition debt, and operates as an injunction against the commencement or continuation of all
legal and nonlegal actions to offset, recover, or collect a debt from the debtor or his property,
whether or not discharge of such debt is waived. 72 11 U.S.C. § 524(a).
In 1994, the Code was amended to ratify the approach taken by the Johns-Manville Corp., which
established a trust under the auspices of the bankruptcy court to satisfy present and future
personal injury claims against it based on exposure to asbestos-containing products. The Code
expressly authorizes the creation of a trust to pay future claims for an asbestos-related disease,
coupled with an injunction to prevent future claimants from suing the debtor. 11 U.S.C. § 524(g).
71
Owen v. Owen, 111 S. Ct. 1833 (1991).
“The injunction is to give complete effect to the discharge and to eliminate any doubt concerning the effect of the
discharge as a total prohibition on debt collection efforts. This paragraph has been expanded over a comparable
provision in [the Bankruptcy Act of 1898] to cover any act to collect, such as dunning by telephone or letter, or
indirectly through friends, relatives, or employers, harassment, threats of repossession, and the like.” H.Rept. 95-595,
supra note 16 at 365-366.
72
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D. Reaffirmation Agreements
Whether or not discharge has been waived, a reaffirmation by the debtor of a dischargeable debt
is enforceable only to any extent enforceable under nonbankruptcy law and only if the agreement
is made before discharge, and is not rescinded by the debtor within thirty days after it becomes
enforceable.
In the case of an individual who enters into a reaffirmation agreement, the court will scrutinize
the agreement to determine that the debtor has entered into it with knowledge of his rights under
Title 11 and with an understanding of its consequences. If the debtor was not represented by an
attorney during the course of negotiating a pre-discharge reaffirmation agreement, the court must
approve the agreement as (i) not imposing an undue hardship on the debtor and (ii) being in the
best interest of the debtor. 73
Nothing contained within the provisions addressing reaffirmation agreements is intended to
prevent a debtor from voluntarily repaying any debt that is otherwise dischargeable under the
Code. 11 U.S.C. § 524(c)(d)&(e).
E. Exceptions to Discharge
Certain debts are excepted from discharge under chapters 7, 11, and 13;74 the dischargeability of
other types of debt must be determined by the court. Among those obligations which are excepted
from discharge are:
•
a customs duty or tax (income, property, employment, etc.) with respect to which
a return was not filed; was filed after the due date and after two years before the
date of filing the petition; was fraudulently prepared for the purpose of willfully
evading or defeating the tax;
•
debts which are not listed or scheduled by the debtor identifying the creditor so
as to permit him to timely file a proof of claim (unless the creditor has actual
knowledge of the case);
•
debts to a spouse, former spouse, or child of the debtor, for alimony to,
maintenance for, or support of such spouse or child, or under a property
settlement agreement;75
•
a debt for a fine, penalty, or forfeiture payable to a governmental unit that is not
compensation for actual pecuniary loss, other than a tax penalty relating to a tax
73
Sears, Roebuck, & Co. entered into a multimillion dollar settlement stemming from a widespread failure to file
reaffirmation agreements with the bankruptcy courts. As a result of an investigation by the Boston Office of the U.S.
Trustee, Sears identified more than 146,000 customers nationwide who signed invalid reaffirmation agreements
between January 1992 and April 1997. 9 BNA Bankr. Law Reporter 1089 (Sept. 11, 1997).
74
Chapter 13 has unique discharge provisions which are discussed infra.
75
A debt may be discharged if it is assigned to another entity either voluntarily or by operation of law, other than an
assignment to the Federal government, to a state government, or to a political subdivision of a state. Likewise, to be
nondischargeable, debt characterized as child support and alimony must actually be in the nature of alimony,
maintenance, or support.
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that is otherwise dischargeable, or imposed with respect to a transaction or event
that occurred three years before the bankruptcy filing; 76
•
a debt for an educational benefit overpayment or loan made, insured, or
guaranteed by a governmental unit, or made under a program funded by a
governmental unit or a nonprofit institution unless failure to grant a discharge
will impose an undue hardship on the debtor and the debtor’s dependents;77
•
a debt which arises from death or personal injury caused by the debtor’s
operation of a motor vehicle while legally intoxicated;
•
a debt that was or could have been listed by the debtor in a prior case under the
Bankruptcy Code or its predecessor, the Bankruptcy Act, in which the debtor
waived discharge or was denied discharge;
•
a debt provided for in any final judicial judgment, order, or consent decree, or
issued by a federal depository institutions regulatory agency, or contained in a
settlement agreement, arising from any act of fraud or defalcation while the
debtor was acting in a fiduciary capacity with respect to a depository institution
or insured credit union;
•
a debt arising from malicious or reckless failure to fulfill a commitment by the
debtor to a federal depository institutions regulatory agency to maintain the
capital of an insured depository institution;
•
a debt for any payment of an order of restitution issued under Title 18 of the U.S.
Code;78
•
a debt incurred to a third-party to pay a tax to the United States that would be
nondischargeable under the provisions above;79
•
a debt for a postpetition fee or assessment from the debtor’s condominium or
cooperative membership association, but only if the fee or assessment is payable
for a period during which the debtor physically occupied or rented the dwelling
unit;80
76
The exception to discharge for fines and penalties includes any condition a state criminal court imposes as part of a
criminal sentence, including a restitution obligation imposed as a condition of probation in state criminal proceedings.
Hence, restitution payments are nondischargeable even though, unlike traditional fines, payments may be forwarded to
the victim and may be calculated by reference to the amount of harm the offender has caused and thereby represent
compensation for actual pecuniary loss. Kelly v. Robinson, 479 U.S. 36 (1986).
77
Nondischargeability was extended to an educational benefit overpayment made or insured by a governmental unit as
well as to “an obligation to repay funds received as an educational benefit, scholarship or stipend” pursuant to
amendments in P.L. 101-647, Title XXXVI, §§ 3621, 3631 (Nov. 29, 1990). Prior to amendments in 1998, student
loans could be discharged if the loan first became due before seven years before the filing of the petition. P.L. 105-244,
§ 971 (Oct. 7, 1998). In Tennessee Student Assistance Corp. v. Hood, 124 S. Ct. 1905 (2004), the Court held that an
adversary proceeding seeking a hardship determination brought by a debtor to discharge a state-held student loan was
not a suit against a state prohibited by the Eleventh Amendment.
78
This exception to discharge was added by § 320934 of the Violent Crime Control and Law Enforcement Act of 1994,
P.L. 103-322, 108 Stat. 1796 (Sept. 13, 1994).
79
This exception to dischargeability was added by § 221 of the 1994 Reform Act. It is intended to protect credit card
companies to the extent that taxes are paid via credit card and “will facilitate individuals’ ability to use their credit
cards to pay their Federal taxes.” H.Rept. 103-835, 103d Congress, 2d Session 51 (1994).
80
This exception, also added by the 1994 Reform Act, expressly does not apply to prepetition fees, which presumably
remain subject to discharge. H.Rept. 103-835 at 56.
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•
a debt for costs, expenses, or a fee imposed by a court for filing a case, motion,
complaint, or appeal regardless of an assertion of poverty by the debtor, or the
debtor’s status as a prisoner;81
•
a debt owed under state law to a state or municipality that is in the nature of
support and is enforceable under part D of title IV of the Social Security Act, 42
U.S.C. § 601 ;82
•
a debt that arises from the violation of federal or state securities laws and
regulations or settlement agreement, or from common law fraud, deceit, or
manipulation in connection with the purchase or sale of any security. 83
Certain types of debt may be discharged unless, at the request of a creditor to whom the debt is
owed, the court, after notice and a hearing, finds the debt to be nondischargeable, namely:84
•
debts for money, property, services, or credit, to the extent obtained by false
pretenses, a false representation, or actual fraud, other than a statement respecting
the debtor’s financial condition; 85 or, by use of a statement in writing that is
materially false with respect to the debtor’s financial condition which the creditor
reasonably relied on, and that the debtor caused to be made or published with
intent to deceive; or, for consumer debts owed to a single creditor aggregating
more than $1,225 for “luxury goods or services” incurred by the debtor within
sixty days before the order for relief, or cash advances aggregating more than
$1,225 obtained by an individual debtor within sixty days before the order for
relief.86
•
debts for fraud or defalcation while acting in a fiduciary capacity, embezzlement,
or larceny;
•
debts for willful and malicious injury by the debtor to another entity or to the
property of another entity; and
81
This provision was added by P.L. 104-134, § 804(b), 110 Stat. 1321-74 (April 26, 1996), the Prison Litigation
Reform Act. It was apparently intended to discourage habeas corpus litigation.
82
This exception was added by P.L. 104-193, § 374, 110 Stat. 2255 (August 22, 1996), the Welfare Reform Act. It is
intended to make nondischargeable debts incurred by a state for child support that may be advanced by the state absent
a court order, or for support rights that may be assigned by a parent to the state for collection against another parent.
83
This exception was added by P.L. 107-204, § 803, 116 Stat. 801 (July 30, 2002).
84
When the debtor is an institution-affiliated party, and the creditor is a federal depository institutions regulatory
agency acting in its capacity as conservator, receiver, or liquidating agent for an insured depository institution which
seeks recovery of a debt arising from fraud, willful injury, or breach of fiduciary duty, it need not specially plead
nondischargeability in most circumstances. 11 U.S.C. § 523(c)(2).
85
In Field v. Mans, 116 S. Ct. 437 (1995), the Supreme Court held that the standard of proof that a creditor must
demonstrate in order to except a debt from discharge as a fraudulent representation is not “reasonable reliance,” but the
less demanding one of justifiable reliance on the representation. And, in Cohen v. De La Cruz, 118 S. Ct. 1212 (1998),
the Court held that nondischargeable debts for “actual fraud” may include all liability arising therefrom, including
treble damages and attorney’s fees. Further, a debt for money promised in a settlement agreement that released the
creditor’s state-law claim for fraud can be treated as debt for money obtained by fraud within the Code’s exception to
discharge. Archer v. Warner, 123 S. Ct. 1462 (2003).
86
When a creditor requests determination of dischargeability of a consumer debt and the debt is discharged, the court
may grant judgment in favor of the debtor for costs and a reasonable attorney’s fee for the proceeding if the court finds
that the position of the creditor was not substantially justified.
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•
a debt incurred by the debtor in the course of a divorce decree, separation
agreement or court order (other than those described above for alimony,
maintenance, or support) unless the debtor does not have the ability to pay such
debt from income or property of the debtor not reasonably necessary to be
expended for the maintenance and support of the debtor and the debtor’s
dependents, and, if the debtor is engaged in a business, for the payment of
expenditures necessary for continuation and preservation of such business; or,
discharging the debt would result in a benefit to the debtor that outweighs the
detrimental consequence to a spouse, former spouse, or child of the debtor. 87
11 U.S.C. § 523.
F. Protection Against Discriminatory Treatment
A governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter,
franchise, or other similar grant to a debtor, or condition such grant or discriminate with respect
to such grant solely because a debtor is insolvent prior to, or has filed for protection under the
Code;88 it may not discriminate against, deny, or terminate the employment of, or discriminate
with respect to employment against a person solely because the debtor is or has been a debtor
under the Bankruptcy Code, or has not paid a debt that is discharged.
No private employer may terminate the employment of, or discriminate with respect to
employment against an individual who is or has been a debtor under the Code solely because of
the insolvency prior to bankruptcy, the bankruptcy filing, or because the debtor has not paid a
debt that is dischargeable or was dischargeable in bankruptcy.89
No government unit or private lender may deny a student loan or loan guarantee to an individual
on account of the individual having filed in, or received a discharge in bankruptcy.90 11 U.S.C. §
525.
87
This qualified exception to dischargeability was added by the Bankruptcy Reform Act of 1994. Committee report
language indicates that the exception is designed to cover types of property settlements other than those embodied in
alimony and support obligations. H.Rept. 103-835 at 54:
In some instances, divorcing spouses have agreed to make payments of marital debts, holding the
other spouse harmless from those debts, in exchange for a reduction in alimony payments. In other
cases, spouses have agreed to lower alimony based on a larger property settlement. If such “hold
harmless” and property settlement obligations are not found to be in the nature of alimony,
maintenance or support, they are dischargeable under current law. The nondebtor spouse may be
saddled with substantial debt and little or no alimony or support. This [exception to discharge] will
make such obligations nondischargeable in cases where the debtor has the ability to pay them and
the detriment to the nondebtor spouse from their nonpayment outweighs the benefit to the debtor of
discharging such debts.
88
In Federal Communications Commission v. Nextwave Personal Communications, 123 S. Ct. 832 (2003), the
Supreme Court held that § 525 prohibited the Federal Communications Commission from revoking licenses held by a
debtor upon the debtor’s failure to make timely payments to it for purchase of the licenses.
89
This provision is not exhaustive of the forms of prohibited discrimination. Congress intended to permit the courts to
expand upon the rule of Perez v. Campbell, 402 U.S. 637 (1971), which held that a state would frustrate the
Congressional policy of a fresh start for a debtor if it were permitted to refuse to renew a drivers license because a tort
judgment resulting from an automobile accident had been unpaid as a result of a discharge in bankruptcy. S.Rept. 95989, supra note 16 at 81.
90
Added by § 313 of the 1994 Reform Act, “[t]his section clarifies the antidiscrimination provisions of the Bankruptcy
(continued...)
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This section does not, however, prevent lenders from considering the fact of a bankruptcy when
deciding to extend credit. Pursuant to 15 U.S.C. § 1681c, credit reporting agencies may report an
individual’s action under the Bankruptcy Code for 10 years after the filing of the order for relief
or the date of adjudication; the 10 year limit does not apply to credit transactions involving a
principal amount of $50,000 or more, the underwriting of life insurance involving a face amount
of $50,000 or more, or the employment of an individual at an annual salary of $20,000 or more.
VII. Chapter 7—Liquidation
A. Appointment of a Trustee
A trustee is always appointed to preside over the consolidation and ultimate distribution of the
estate in a chapter 7 liquidation.
1. Interim Trustee
Promptly after an order for relief is entered, the U.S. Trustee is directed to appoint an interim
trustee. If necessary, the U.S. Trustee may serve as an interim trustee. 11 U.S.C. § 701.
2. Election of a Trustee
At the first meeting of creditors, they may vote to elect one person to serve as trustee if election is
requested by creditors who may vote. A creditor may vote only if he (i) holds an allowable,
undisputed, fixed, liquidated, unsecured claim that is not entitled to priority, but is entitled to
distribution; (ii) does not have an interest materially adverse to the general unsecured creditors;
and (iii) is not an insider. A candidate for trustee is elected if general unsecured creditors holding
20% of the amount of such claims actually vote, and if the candidate receives a majority of those
votes. The interim trustee serves as the permanent trustee in the case if a trustee is not so elected.
11 U.S.C. § 702.
3. Successor Trustee
If an elected trustee fails to qualify, dies, resigns, or is removed for cause during the case, the
creditors may elect another trustee in the manner described above to fill the vacancy.
Pending such election, or if the creditors do not elect a successor trustee, the United States
Trustee may appoint an interim or successor trustee, or, if necessary, serve as trustee in the case.
11 U.S.C. § 703.
(...continued)
Code to ensure that applicants for student loans or grants are not denied those benefits due to a prior bankruptcy.”
H.Rept. 103-835 at 58.
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B. Duties of the Trustee.
A chapter 7 trustee must:
•
collect and reduce to money the property of the estate and close the estate as
expeditiously as is compatible with the best interests of the parties involved;
•
be accountable for all property received;
•
ensure that the debtor performs his declared intention with respect to property to
be retained, surrendered, exempted, or redeemed, and with respect to debts which
the debtor intends to reaffirm;
•
investigate the debtor’s financial affairs;
•
if a purpose would be served, examine proofs of claims and object to the
allowance of claims that appear to be improper;
•
if advisable, oppose the discharge of the debtor;
•
unless the court orders otherwise, furnish such information concerning the estate
that is requested by a party in interest;
•
if the business of the debtor is authorized to be operated, file with the court, with
the U.S. Trustee, and with appropriate governmental tax units, periodic reports
and summaries of the operation of such business, including a statement of
receipts and disbursements; and
•
make a final report and a final account of the administration of the estate with the
court and with the U.S. Trustee.
11 U.S.C. § 704.
C. Creditors’ Committee
Unsecured creditors entitled to vote for a trustee may also elect a creditors’ committee composed
of not less than three nor more than eleven creditors. The committee may consult with the trustee
or the U.S. Trustee in connection with the administration of the estate, make recommendations
respecting the performance of the trustee’s duties, and submit to the court or to the U.S. Trustee
any question affecting the administration of the estate. 11 U.S.C. § 705.
D. Authorization to Operate Business
If it is consistent with the orderly liquidation of the estate, and in the estate’s best interest, the
court may authorize a trustee to operate the debtor’s business for a limited period. 11 U.S.C. §
721.
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E. Redemption of Personal Property
The debtor may redeem tangible personal property intended primarily for personal, family, or
household use, from a lien securing a dischargeable consumer debt by paying the lienholder the
amount of his allowed claim secured by such lien. 91 11 U.S.C. § 722.
F. Rights of Partnership Trustee Against General Partners
This statute provides that each general partner in a partnership debtor is liable to the partnership’s
trustee for any deficiency in partnership assets to pay in full all administrative expenses and all
claims against the partnership to the extent that the general partner is personally liable under
applicable nonbankruptcy law.92
The trustee may seek recovery of any deficiency from any general partner who is not a debtor in a
bankruptcy case. The court may order the nondebtor partner to indemnify the estate or not to
dispose of property pending a determination of the deficiency.
If the aggregate recovered by the trustee from the estates of the general partners exceeds the
deficiency, the court, after notice and hearing, shall determine an equitable distribution for the
surplus which the trustee shall distribute to the estates of the general partners. 11 U.S.C. § 723.
G. Avoidance and Distribution of Certain Liens
The trustee is permitted to avoid a lien that secures a fine, penalty, forfeiture, or multiple,
punitive, or exemplary damages claims to the extent that the claim is not compensation for actual
pecuniary loss.
The statute also deals with the order of distribution of property upon which there may be an
unavoidable tax lien. The Code subordinates payment of certain tax liens in favor of other
interests. Property, or proceeds would first be distributed to a holder of an allowed claim secured
by a lien on the property that is senior to the tax lien; second, for administrative expenses and to
holders of specified high-priority unsecured claims; third, to the holder of the tax lien; fourth, to
the holder of an allowed claim secured by a lien that is junior to the tax lien; fifth, to the holder of
the tax lien, if there are still proceeds for distribution; and sixth, to the estate. 11 U.S.C. § 724.
91
“The right to redeem extends to the whole of the property, not just the debtor’s exempt interest in it. Thus, for
example, if a debtor owned a $2,000 car, subject to a $1,200 lien, the debtor could exempt his $800 interest in the car.
The debtor is permitted a $1,500 exemption in a car, proposed 11 U.S.C. § 522(d)(2) [note: 11 U.S.C. § 522(d)(2)
currently permits a $2400 exemption in an automobile]. This section permits him to pay the holder of the lien $1,200
and redeem the entire car, not just the remaining $700 [sic] of his exemption. The redemption is accomplished by
paying the holder of the lien the amount of the allowed claim secured by the lien. The provision amounts to a right of
first refusal for the debtor in consumer goods that might otherwise be repossessed.” H.Rept. 95-595, supra note 16 at
380-381.
92
This provision was amended by § 212 of the 1994 Reform Act to clarify “that a partner of a registered limited
liability partnership would only be liable in bankruptcy to the extent a partner would be personally liable for a
deficiency according to the registered limited liability statute under which the partnership was formed.” H.Rept. 103835, 103d Congress, 2d Session 47 (1994).
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H. Distribution of Property of the Estate
The order for distribution of property of the estate which is not designated as collateral for a
secured interest is set forth at 11 U.S.C. § 726, namely:
•
in payment of administrative expenses and high-priority unsecured claims set
forth at 11 U.S.C. § 507, discussed supra;
•
to general unsecured creditors whose claims are timely filed (either by the
creditor, or a trustee, debtor or codebtor on behalf of the creditor) or are tardily
filed because the creditor had no notice or actual knowledge of the case, and
proof of such claim is filed in time to permit its payment;
•
to general unsecured creditors who tardily file their claim;
•
in payment of secured or unsecured allowed claims for a fine, penalty, forfeiture,
or for multiple, exemplary, or punitive damages, arising before the earlier of the
order for relief or the appointment of a trustee, to the extent that they are not
compensation for actual pecuniary loss suffered by the claimholder;
•
in payment of post-petition interest (at the legal rate) on any claim above; and
•
to the debtor.
Claims within a particular class are to be paid pro rata when there are not enough funds to pay
each claimant in full. A superpriority, however, is conferred upon administrative expenses
incurred under chapter 7 over administrative expenses which arose in another chapter (i.e., 11, 12,
or 13) before it was converted to chapter 7, and over expenses incurred by a custodian in
preserving a debtor’s property prior to its turnover by the custodian to a trustee.
Community property of the debtor and spouse are segregated and dealt with separately.93
I. Discharge
1. Obtaining Discharge
The discharge is at the heart of the “fresh start” for the debtor.94 The court is required to grant the
debtor a discharge in bankruptcy unless one of ten of the following conditions are met:
•
the debtor is not an individual;95
•
the debtor has, with intent to hinder, delay, or defraud a custodial officer of the
estate, or a creditor, transferred, removed, destroyed, mutilated, or concealed his
93
11 U.S.C. § 726(c) provides for the distribution of the community property. The order of distribution is not
substantially different from that discussed above, but provision is made for community claims against the debtor or the
debtor’s spouse.
94
H.Rept. 95-595, supra note 16 at 384.
95
“This is a change from present law [Bankruptcy Act of 1898], under which corporations and partnerships may be
discharged in liquidation cases, though they rarely are. The change in policy will avoid trafficking in corporate shells
and in bankruptcy partnerships. ‘Individual’ includes a deceased individual, so that if the debtor dies during the
bankruptcy case, he will nevertheless be released from his debts, and his estate will not be liable for them.” Id.
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property within one year before the filing date of the petition; or property of the
estate after such filing date; or has permitted such acts to be done;
•
the debtor has concealed, destroyed, mutilated, falsified or failed to keep or
preserve records, books, documents, papers, etc. from which his financial
condition or business transactions might be ascertained—unless the failure is
justified under the circumstances;
•
the debtor knowingly and fraudulently made a false oath or account; presented a
false claim; gave, received, or attempted to obtain money, property, or advantage,
for acting or forbearing to act; or, withheld from an officer of the estate any
information relating to the debtor’s financial affairs;
•
the debtor, before determination of a denial of discharge, fails to satisfactorily
explain a deficiency of assets to meet his liabilities;
•
the debtor refuses to obey lawful court orders (other than one to respond to a
material question or to testify); to respond to a material question approved by the
court on the ground of the privilege against self-incrimination after the debtor has
been granted immunity; to respond to a court approved question on a ground
other than a properly invoked privilege against self-incrimination;
•
the debtor commits any act specified above on or within one year before the
filing of the petition, or during the case, or in connection with another bankruptcy
case concerning an insider;
•
the debtor has been granted a discharge under chapter 7 or chapter 11 in a case
commenced within six years before the filing of the petition;
•
the debtor has been granted a discharge under either chapter 12 or 13 in a case
commenced within six years before the date of the filing of the petition, unless
payments under the reorganization plan totaled at least (i) 100 percent of the
allowed unsecured claims in the case, or (ii) 70 percent of such claims and the
plan was proposed by the debtor in good faith and was the debtor’s best effort; or
•
the court approves a written waiver of discharge executed by the debtor after the
order for relief is entered. 11 U.S.C. § 727(a).
2. Effect of Discharge
With the exception of debts that are nondischargeable, a chapter 7 discharge, when granted,
discharges the debtor from all debts and liability on claims that arose before the date of the order
for relief. It is irrelevant whether or not a proof of claim was filed with respect to the debt, and
whether or not the claim based on the debt was allowed. 11 U.S.C. § 727(b).
3. Objection To and Revocation Of the Debtor’s Discharge
The trustee, a creditor, or the U.S. Trustee may ask the court to revoke a discharge if it was
obtained through the fraud of the debtor and the requesting party did not know of the fraud until
after the discharge was granted. The complaint for revocation must be made within one year of
the grant of discharge. Other grounds for revocation are the debtor’s having acquired property of
the estate, having become entitled to acquire property, and knowingly and fraudulently failing to
report the acquisition or entitlement, or to surrender the property to the trustee; or, if the debtor
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refused to obey lawful orders of the court and failed to testify when required to do so. Complaint
must be made before the later of one year after the granting of the discharge or the date the case is
closed. The court, after notice and a hearing, may revoke the discharge on these grounds. 11
U.S.C. § 727(c), (d), & (e).
J. Special Tax Provisions
For purposes of state and local income taxes, the taxable period of a debtor that is an individual
terminates on the date the order for relief is entered under chapter 7, unless the case was
converted from chapter 11 or 12.
If an individual or corporate debtor has net taxable postpetition income, or if the debtor is a
partnership, the trustee shall file a return for each taxable period during which the case was
pending.
Special provision is made for the taxation of partnerships. 11 U.S.C. § 728.
VIII. Chapter 11—Reorganization
Most individuals or businesses that are eligible to file under chapter 7 may file for reorganization
under chapter 11.96 This chapter, however, is designed to accommodate complicated, publiclyheld corporate reorganizations as well as those of lesser magnitude and, consequently, it is
procedurally more elaborate and expensive to effectuate than a reorganization under chapter 12 or
13. To illustrate, this chapter contemplates the creation of creditor committees, the employment of
professionals to assist the committees, the solicitation of creditor votes to accept or reject a
reorganization plan, and the exchange and issuance of new securities by the debtor. The
applicable time frames for action under chapter 11 are adjusted accordingly.
The Bankruptcy Reform Act of 1994 amended chapter 11 to expedite procedures for “small
business” reorganizations.97 A qualified small business debtor would be permitted to dispense
with creditor committees; would have an exclusivity period for filing a plan of 100 days; and,
would be subject to more liberal provisions for disclosure and solicitation of acceptances for a
proposed reorganization plan.
Highlights of the statutory requirements for a chapter 11 reorganization are examined below.
96
Although chapter 11 is clearly designed to facilitate business, i.e., corporate reorganization, an individual consumer
debtor not engaged in business is permitted to file. Toibb v. Radloff, 111 S. Ct. 2197 (1991). The 1994 Reform Act
amendments significantly raised the debt levels for filing under chapter 13. Hence, many individuals who could not file
under chapter 13 and of necessity filed to reorganize under chapter 11, may now avail themselves of chapter 13.
97
A “small business” is one defined as “a person engaged in commercial or business activities . . . whose aggregate
noncontingent liquidated secured and unsecured debts as of the date of the petition do not exceed $2,000,000.” 11
U.S.C. § 101(51C).
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A. Creditors’ and Equity Security Holders’ Committees
As soon as practicable after entry of an order for relief in a chapter 11 reorganization case, the
U.S. Trustee appoints a committee of unsecured claim holders, and such additional committees as
may be requested by a party or parties in interest. A small business debtor may, for cause, request
the court to waive appointment of a creditors committee.
Ordinarily, the committee is composed of creditors willing to serve holding the seven largest
claims of the kind represented by the committee (e.g., an equity security holders’ committee
would be composed of those persons holding the seven largest amounts of equity securities). Or,
the committee might be comprised of the members of a creditor’s committee organized before the
order for relief if it was fairly chosen and is representative of the different kinds of claims to be
represented.
If the committee membership is not representative of the different claims and interests, the court,
on request of a party in interest, may order the appointment of additional committees. The U.S.
Trustee will appoint the committees. 11 U.S.C. § 1102.
B. Power and Duties of Committees
A creditors’ committee may:
•
with court approval, employ accountants, attorneys, or other agents to represent
or perform services for the committee;
•
consult with the trustee or debtor in possession concerning the administration of
the case;
•
investigate the debtor’s financial condition, the operation of its business and the
desirability of continuing such business, and any other matter relevant to the case
or the formulation of the plan;
•
participate in the formulation of a plan and collect and file acceptance of the
plan;
•
request the appointment of a trustee or examiner if one has not been previously
appointed; and
•
perform such other services as are in the interest of those represented.
11 U.S.C. § 1103.
C. Appointment of Trustee or Examiner; Termination of the
Trustee’s Appointment
At any time after the commencement of the case but before confirmation of a plan, on request of
a party in interest or the U.S. Trustee, the court, after notice and a hearing, may order the
appointment of a trustee (1) for cause, including fraud, dishonesty, incompetence, or gross
mismanagement of the affairs of the debtor by current management; or (2) if the appointment is in
the interest of creditors.
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If the court does not order the appointment of a trustee to run the debtor’s business, it may
appoint an examiner to conduct an investigation of the debtor, including an investigation of any
allegations of fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity, if the
appointment is in the interests of creditors, or the debtor’s unsecured debts to an insider exceed
$5,000,000. 11 U.S.C. § 1104.
The court may, at any time before confirmation of a plan, terminate the trustee’s appointment and
restore the debtor to possession and management of the debtor’s business. 11 U.S.C. § 1105.
D. Duties of a Trustee or Examiner
If a trustee or examiner is appointed in the manner discussed above, he or she must perform the
following duties:
•
account for all property received;
•
if a purpose would be served, examine proofs of claims and object to improper
claims;
•
unless otherwise ordered by the court, furnish such information requested by a
party in interest concerning the estate’s administration;
•
if operation of the debtor’s business is authorized, file periodic reports and
summaries of such operation, including a statement of receipts and
disbursements, with those governmental units responsible for collecting and
determining a tax;
•
make and file a final report and account of the estate’s administration with the
court;
•
if the debtor has not done so, file a list of creditors; a statement of the debtor’s
financial affairs; and a schedule of assets and liabilities;
•
except to the extent the court orders otherwise, investigate the conduct and the
financial condition of the debtor, the operation of the debtor’s business and the
desirability of the continuance of the business;
•
file a statement with the court and with appropriate creditors’ committee
summarizing the investigation, including any facts pertaining to fraud,
dishonesty, incompetence, misconduct, mismanagement, or irregularity in the
management of the affairs of the debtor, or to a cause of action available to the
estate;
•
as soon as practicable, file a reorganization plan or a report of why the trustee
will not file a plan, or recommend conversion of the case to one under chapter 7,
12, or 13, or dismissal;
•
furnish information required by taxing authorities for any year for which the
debtor has not filed a tax return; and
•
after confirmation of a plan, file such reports as are necessary or as the court
orders.
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An examiner may be required to perform the investigative duties specified above, or any other
duties of the trustee that the court orders the debtor in possession not to perform. 11 U.S.C. §
1106.
E. Rights, Powers, and Duties of a Debtor in Possession
This section places a debtor in possession in the shoes of a trustee in every way.98 A debtor in
possession has all the rights of a trustee with respect to management of the bankruptcy estate
during reorganization, subject to such limitation or conditions as the court prescribes, and
excluding the investigative and reporting duties which a trustee would perform. 11 U.S.C. § 1107.
F. Authorization to Operate a Business
Unless the court orders otherwise, a chapter 11 debtor’s business may continue to operate, i.e., it
is not necessary to go to court to obtain an order authorizing the business’ operation. 11 U.S.C. §
1108.
G. Right to be Heard
This provision grants the Securities and Exchange Commission the right to appear, raise, and be
heard on any issue in a reorganization case, but not to appeal from any judgment, order, or decree
entered in the case.
The same right to be heard is extended also to creditors, equity security holders, creditors’ and
equity security holders’ committees, the debtor, the trustee, or any indenture trustee or other party
in interest.99 11 U.S.C. § 1109.
H. Claims and Interests
In a chapter 11 reorganization, every unsecured creditor and equity security holder need not file a
proof of claim. The debtor’s schedules of claims will be accepted unless a claim is listed as
disputed, contingent, or unliquidated.
A secured claim is treated as a recourse claim whether or not the claim is non-recourse. Thus,
when a secured creditor is undersecured, the creditor will have an unsecured claim for the
deficiency, regardless of whether a claim for the deficiency was permitted in the original loan. An
additional benefit is conferred upon chapter 11 secured creditors which permits them to elect to
be treated as secured up to the full amount of the allowable claim, even if it exceeds the value of
the collateral. This preferred status terminates if the property securing the claim is sold during the
proceeding or under the plan. The preferred status also terminates if the class (by at least 2/3rds in
98
H.Rept. 95-595, supra note 16 at 404.
Bankruptcy Rule 2018 gives the bankruptcy court discretion to permit any interested entity to intervene generally or
with respect to any specified matter. It permits a State Attorney General to appear and be heard on behalf of consumer
creditors if the court determines the appearance is in the public interest, but the Attorney General, like the SEC, may
not appeal from a bankruptcy court decision. Likewise, in a chapter 9 or 11 case, a labor union or employees’
association representative is given a right to be heard, but not a right of appeal.
99
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amount and more than ½ in number of the allowed claims) elects not to be so treated. A class may
elect the application only if the security is not of inconsequential value and, if the creditor is a
recourse creditor, the collateral is not sold during the proceeding or under the plan.
If the election is made, the claim is a secured claim to the extent that
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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.