Dan Garrison 0000-00-00 00:00:00
At the risk of having my club membership rights revoked by my bankruptcy attorney colleagues, I thought that it might be helpful in my first column in Attorney at Law to explain a bit about our “secret language.” Like many specialized areas, bankruptcy law has its own vernacular, an understanding of which goes a long way toward understanding the process and its effects. In future columns, I’ll begin unraveling the mysteries of both consumer and business bankruptcies and discussing how a bankruptcy affects the interests of the parties involved. The Bankruptcy Code Our current system of bankruptcy was enacted in 1978, and is governed by the Bankruptcy Code (11 U.S.C. §§ 101-1532). The Bankruptcy Code is divided into nine chapters, certain of which contain the provisions that relate solely to the eponymous types of bankruptcies with which most people are familiar: Chapters 7, 11 and 13. There also are special (and somewhat obscure) types of bankruptcy cases for insolvent municipalities (Chapter 9), family farmers and fishermen (Chapter 12), and cross-border insolvency matters (Chapter 15). The first three chapters cover other procedural and substantive areas that apply to most if not all of the different types of bankruptcy, and are titled “General Provisions” (Chapter 1), “Case Administration” (Chapter 3), and “Creditors, Debtor and Estate” (Chapter 5). Oddly, the Bankruptcy Code does not contain chapters 2, 4, 6, 8, 10 or 14. Welcome to the intuitive world of bankruptcy! The Debtor The debtor, simply put, is the party in bankruptcy. Debtors can be natural persons or a wide variety of business organizations. The Petition & Petition Date Bankruptcy cases are commenced by filing a “petition for relief”, and the date that the petition is filed is called [drumroll, please] the “petition date”. The petition seeks the entry of an “order for relief” which simply means that the protections of bankruptcy have been granted. In a voluntary case the order for relief is automatic and deemed to have been entered on the petition date; in an involuntary case, a debtor can contest whether an order for relief should be entered; if it is, the order is deemed also to have been entered on the petition date. The Estate The bankruptcy estate is a legal fiction that arises on the petition date and comprises all of the debtor’s legal and equitable interests in non-exempt property (tangible and intangible), and certain legal rights or causes of action that arise from the filing of the bankruptcy. In an individual Chapter 7 case, the estate does not include future income or (generally) property acquired after the petition date. In both Chapter 11 and 13 cases, the estate generally includes these assets excepted from the estate in Chapter 7. The Automatic Stay and Stay Relief With limited exceptions, the filing of a petition imposes a stay of any action to enforce debts of, file or continue non-bankruptcy litigation against, or exercise control over property of, the debtor. This “King’s X” is one of the primary reasons why many debtors file bankruptcy petitions—to stop foreclosures, enforcement of judgments, collection efforts, and termination of contracts and leases. In order for a creditor to start or continue any of the foregoing actions, they must ask the bankruptcy court—through a motion— for relief from the automatic stay. Colloquially, this is referred to as seeking “stay relief”. Schedules of Assets & Liabilities and Statement of Financial Affairs The so-called “schedules” and “SOFA” or “statement” are form-based documents required to be filed by every debtor very early in their bankruptcy case. They provide lists of real property and personal property assets, secured and unsecured liabilities, and other useful and comprehensive information about the debtor, its current situation and some history of its transactions with third parties. Chapter 7 Liquidation A Chapter 7 bankruptcy case can be filed by a flesh-and-blood person or a business organization. It is a proceeding to liquidate the debtor’s estate and to distribute the proceeds thereof to creditors according to the absolute priority rule (see below). A trustee is always appointed—automatically by the United States Trustee’s office—when a Chapter 7 case is commenced. Notwithstanding the liquidation purpose of Chapter 7, businesses can continue to be run by the Chapter 7 trustee briefly in order to facilitate a sale of the assets as a going concern. Chapter 11 Reorganization A Chapter 11 bankruptcy case also can be filed by a flesh-and-blood person or a business organization. It is intended to accomplish a reorganization of the debtor’s affairs, but Chapter 11 cases commonly also involve orderly liquidations, which are referred to as “liquidating 11s.” Go figure. Although a Chapter 11 case may be converted to a Chapter 7, the goal and ultimate result of a Chapter 11 case is a confirmed (court-approved) Chapter 11 plan of reorganization. Chapter 13 Debt Adjustment A Chapter 13 bankruptcy can only be filed by a flesh-and-blood person with a regular income, and historically has been called a “wage earner’s case.” In a Chapter 13, a trustee is appointed to oversee the debtor’s performance under a Chapter 13 plan, which typically calls for the debtor to make payments of disposable income to the trustee for 5 years, which the trustee in turn distributes pro rata to creditors. The Discharge Flesh-and-blood debtors receive discharges in bankruptcy cases. A discharge is the proverbial “fresh start” absolving the debtor of legal responsibility from most, if not all, of their debts. Business organizations, whether they file Chapter 7 or Chapter 11 bankruptcies, do not receive discharges, although in a Chapter 11 there may be a permanent injunction imposed prohibiting creditors from seeking payment of anything more than is approved in the debtor’s confirmed Chapter 11 plan. Debtor in Possession vs. Trustee In Chapter 11 cases, unlike Chapters 7 or 13, a trustee is not automatically appointed, and the debtor takes on the responsibility of being a quasi-trustee called a “debtor in possession.” The term’s meaning is relatively intuitive: the debtor remains in possession of his/her/its own assets and can continuing running the estate’s business in the ordinary course—subject, not surprisingly, to a number of restrictions and reporting. For a trustee to be appointed, typically someone must move the bankruptcy court to order the appointment of a trustee for cause. A debtor in possession has the same powers and duties of a trustee. The 341 Meeting or First Meeting of Creditors One of the common procedural attributes of all bankruptcy cases is the 341 Meeting or First Meeting of Creditors. In cases where a trustee is appointed, the trustee conducts this meeting. In Chapter 11 cases where there is a debtor in possession, a trial attorney from the U.S. Trustee’s office will conduct the meeting. The meeting is not conducted before the bankruptcy judge. The debtor is sworn, and the trustee asks a number of stock questions as well as any other specific questions they may have. Creditors may then ask limited questions while the debtor is under oath. The 341 meeting is usually held 30-45 days after the petition date. The Committee In Chapter 11 cases, the U.S. Trustee’s office will survey the largest unsecured creditors in the case to assess interest in forming an official committee of unsecured creditors. In very complicated cases, there might also be official committees of different types of creditors, bondholders, investors and other constituencies. Official committees have standing to participate in all events of the case and judges often factor committees’ positions heavily on major matters of concern. The Absolute Priority Rule The “Absolute Priority Rule” is as close to an “absolute” as you can get in bankruptcy, and it governs how value in a bankruptcy is distributed among creditors and other parties. A helpful metaphor is a to think of the Rule as a “champagne waterfall” like you’d see on a cruise ship brochure. Each champagne bottle represents an asset of the bankruptcy estate. If a secured creditor has a lien against a champagne bottle, it gets to drink from that bottle alone until its “thirst”—the value of its claim—is satisfied. If there’s champagne left after the secured creditor drinks, then the steward pours it into the glass at the top of the pyramid—as well as pouring champagne from any bottle not subject to a secured creditor’s lien. Starting at the top of the pyramid of glasses, each tier represents a class of creditors whose claims and legal rights are similar. If the steward runs out of champagne before it spills over from a higher tier to the next lower tier, the creditors with partially-full glasses get a “sip”, and the disappointed creditors in the lower level go thirsty. Bankruptcy is like that—without the happy, bubbly feeling. Now that I’ve undoubtedly validated your law school commitment to never become a bankruptcy attorney, we’ll move on in future installments to the really fun stuff.
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