Bankruptcy

BASICS

Leonidas Ralph Mecham, Director

Administrative Office
of the United States Courts
 Bankruptcy
BASICS
Public Information Series

Bankruptcy Judges Division

Administrative Office
of the United States Courts

J U N E 2000
Revised Second Edition
While the information presented in this pamphlet is accurate as of the date of pub-
lication, it should not be cited or relied upon as legal authority. It should not be used

as a substitute for reference to the United States Bankruptcy Code (title 11, United
States Code) and the Federal Rules of Bankruptcy Procedure, both of which may be

reviewed at local law libraries, or to local rules of practice adopted by each

bankruptcy court. Finally, this pamphlet should not substitute for the advice of

competent legal counsel. For additional copies, please contact the Bankruptcy
Judges Division, Administrative Office of the United States Courts, (202) 502-1900.
 Table of
CONTENTS
Introduction 1

The Discharge in Bankruptcy 5

Chapter 7. Liquidation Under the Bankruptcy Code 11

Chapter 13. Individual Debt Adjustment 18

Chapter 11. Reorganization Under the Bankruptcy Code 24

Chapter 12. Family Farmer Bankruptcy 38

Chapter 9. Municipality Bankruptcy 44

SIPA. Securities Investor Protection Act 53

Bankruptcy Terminology 61
 Bankruptcy
BASICS
A Public Information Series of
the Bankruptcy Judges Division
THE PAMPHLET competent legal counsel or a financial
The Bankruptcy Judges Division’s Public expert. Neither the Bankruptcy Judges
Information Series pamphlet provides Division nor the Administrative Office
basic information to debtors, creditors, of the United States Courts can pro-
court personnel, the media, and the gen- vide legal or financial advice. Such
eral public on different aspects of the advice may be obtained from a com-
federal bankruptcy laws. The series is petent attorney, accountant, or finan-
also designed to provide individuals who cial adviser.
may be considering bankruptcy with a
basic explanation of the different chap- THE PROCESS
ters under which a bankruptcy case may Article I, Section 8, of the United States
be filed and to answer some of the most Constitution authorizes Congress to
commonly asked questions about the enact “uniform Laws on the subject of
bankruptcy process. Bankruptcies.” Under this grant of
This pamphlet provides general authority, Congress enacted the “Bank-
information only. While every effort ruptcy Code” in 1978. The Code,
has been made to ensure that the infor- which is codified as title 11 of the
mation contained in it is accurate as of United States Code, has been amended
the date of publication, it is not a full several times since its enactment. It is
and authoritative statement of the law the uniform federal law that governs all
on any particular topic. The informa- bankruptcy cases.
tion presented in the pamphlet should The procedural aspects of the bank-
not be cited or relied upon as legal ruptcy process are governed by the
authority and should not be used as a Federal Rules of Bankruptcy Procedure
substitute for reference to the United (often called the “Bankruptcy Rules”)
States Bankruptcy Code (title 11, and local rules of bankruptcy. The
United States Code) and the Federal Bankruptcy Rules contain a set of official
Rules of Bankruptcy Procedure. forms for use in bankruptcy cases. The
Most importantly, the pamphlet Bankruptcy Code and Bankruptcy Rules
should not substitute for the advice of (and local rules) set forth the formal legal

INTRODUCTION • 1
 procedures for dealing with the debt process is carried out by a trustee who
problems of individuals and businesses. is appointed to oversee the case.
There is a bankruptcy court for each A debtor’s involvement with the
judicial district in the country. Each bankruptcy judge is usually very limited.
state has one or more districts. There A typical chapter 7 debtor will not
are 90 bankruptcy districts across the appear in court and will not see the
country. The bankruptcy courts gener- bankruptcy judge unless an objection is
ally have their own clerk’s offices. raised in the case. A chapter 13 debtor
may only have to appear before the
bankruptcy judge at a plan confirmation
hearing. Usually, the only formal pro-
The court official ceeding at which a debtor must appear is
the meeting of creditors, which is usual-
with decision-making ly held at the offices of the United States
trustee. This meeting is informally called
power over federal a “341 meeting” because section 341 of
the Bankruptcy Code requires that the
bankruptcy cases debtor attend this meeting so that credi-
tors can question the debtor about debts
is the United States and property.
A fundamental goal of the federal
bankruptcy judge, bankruptcy laws enacted by Congress
is to give debtors a financial “fresh
a judicial officer of start” from burdensome debts. The
Supreme Court made this point about
the United States the purpose of the bankruptcy law in a
1934 decision:
district court.
[I]t gives to the honest but
unfortunate debtor…a new op-
portunity in life and a clear field
The court official with decision-mak- for future effort, unhampered by
ing power over federal bankruptcy the pressure and discouragement
cases is the United States bankruptcy of preexisting debt.
judge, a judicial officer of the United
States district court. The bankruptcy Local Loan v. Hunt, 292 U.S. 234, 244
judge may decide any matter connected (1934). This goal is accomplished
with a bankruptcy case, such as eligi- through the bankruptcy discharge,
bility to file or whether a debtor should which releases debtors from personal
receive a discharge of debts. Much of liability from specific debts and pro-
the bankruptcy process is administra- hibits creditors from ever taking any
tive, however, and is conducted away action against the debtor to collect
from the courthouse. In cases under those debts. This pamphlet describes
chapter 7, 12, or 13, and sometimes in the Discharge in Bankruptcy in a ques-
chapter 11 cases, this administrative tion and answer format, discussing the

2 • INTRODUCTION
timing of the discharge, the scope of the a house. It is also favored because it
discharge (what debts are discharged allows the debtor to propose a “plan”
and what debts are not discharged), to repay creditors over time—usually
objections to discharge, and revocation three to five years. At a confirmation
of the discharge. It also describes what hearing, the court either approves or
a debtor can do if a creditor attempts to disapproves the plan, depending on
collect a discharged debt after the whether the plan meets the Bankruptcy
bankruptcy case is concluded. Code’s requirements for confirmation.
There are five basic types of bank- Chapter 13 is very different from chap-
ruptcy cases provided for under the ter 7, since the chapter 13 debtor usu-
Bankruptcy Code, each of which is dis- ally remains in possession of the prop-
cussed in this pamphlet. The cases are erty of the estate and makes payments
traditionally given the names of the to creditors, through the trustee, based
chapters that describe them. on the debtor’s anticipated income over
Chapter 7, entitled Liquidation, con- the life of the plan. Unlike chapter 7,
templates an orderly, court-supervised the debtor does not receive an immedi-
procedure by which a trustee collects ate discharge of debts. The debtor must
the assets of the debtor’s estate, reduces complete the payments required under
them to cash, and makes distributions the plan before the discharge is
to creditors, subject to the debtor’s received. The debtor is protected from
right to retain certain exempt property lawsuits, garnishments, and other cred-
and the rights of secured creditors. itor action while the plan is in effect.
Because there is usually little or no The discharge is also considerably
nonexempt property in most chapter 7 broader (i.e., more debts are eliminat-
cases, there may not be an actual liqui- ed) under chapter 13 than the discharge
dation of the debtor’s assets. These under chapter 7.
cases are called “no-asset cases.” A Chapter 11, entitled Reorganization,
creditor holding an unsecured claim ordinarily is used by commercial enter-
will get a distribution from the bank- prises that desire to continue operating
ruptcy estate only if the case is an asset a business and repay creditors concur-
case and the creditor files a proof of rently through a court-approved plan of
claim with the bankruptcy court. In reorganization. The chapter 11 debtor
most chapter 7 cases, the debtor has the exclusive right to file a plan of
receives a discharge that releases the reorganization for the first 120 days
debtor from personal liability for cer- after the order for relief and must pro-
tain dischargeable debts. The debtor vide creditors with a disclosure state-
normally receives a discharge just a few ment containing information adequate
months after the petition is filed. to enable creditors to evaluate the plan.
Chapter 13, entitled Adjustment of The court ultimately approves (con-
Debts of an Individual With Regular firms) or disapproves the plan of re-
Income, is designed for an individual organization. Under the confirmed
debtor who has a regular source of plan, the debtor can reduce its debts by
income. Chapter 13 is often preferable repaying a portion of its obligations and
to chapter 7 because it enables the discharging others. The debtor can also
debtor to keep a valuable asset, such as terminate burdensome contracts and

INTRODUCTION • 3
leases, recover assets, and rescale its Since being established by Congress in
operations in order to return to prof- 1970, the Securities Investor Protection
itability. Under chapter 11, the debtor Corporation has protected investors
normally goes through a period of con- who deposit stocks and bonds with bro-
solidation and emerges with a reduced kerage firms by ensuring that every cus-
debt load and a reorganized business. tomer’s property is protected, up to
Chapter 12, entitled Adjustment of $500,000 per customer.
Debts of a Family Farmer with Regular The bankruptcy process is complex
Annual Income, provides debt relief to and relies on legal concepts like the
family farmers with regular annual “automatic stay,” “discharge,” “exemp-
income. The process under chapter 12 tions,” and “substantial abuse.” There-
is very similar to that of chapter 13 fore, the final chapter of this booklet is a
under which the debtor proposes a plan glossary of Bankruptcy Terminology
to repay debts over a period of time— which explains, in layman’s terms, most
no more than three years unless the of the legal concepts that apply in cases
court approves a longer period, not filed under the Bankruptcy Code.
exceeding five years. There is also a
trustee in every chapter 12 case whose
duties are very similar to those of a
chapter 13 trustee. The chapter 12
trustee’s disbursement of payments to
creditors under a confirmed plan paral-
lels the procedure under chapter 13.
Chapter 12 allows a family farmer to
continue to operate the farm while the
plan is being carried out.
Chapter 9, entitled Adjustment of
Debts of a Municipality, provides
essentially for reorganization, much
like a reorganization under chapter 11.
Only a “municipality” may file under
chapter 9, which includes cities and
towns, as well as villages, counties, tax-
ing districts, municipal utilities, and
school districts.
This pamphlet also contains a descrip-
tion of liquidation proceedings under
the Securities Investor Protection Act.
Although the Bankruptcy Code provides
for a stockbroker liquidation proceed-
ing, it is far more likely that a failing
brokerage firm will find itself involved
in a SIPA proceeding. The purpose of
SIPA is to return to investors securities
and cash left with failed brokerages.

4 • INTRODUCTION
The Discharge DISCHARGE
in Bankruptcy

The bankruptcy discharge varies From an individual

depending on the type of case a debtor
files: chapter 7, 11, 12, or 13. This debtor’s standpoint, one
Public Information Series pamphlet
attempts to answer some basic ques- of the primary goals of
tions about the discharge available to
individual debtors under all four chap- filing a bankruptcy case
ters including:
1. What is a discharge in bankruptcy?
is to obtain relief from
2. When does the discharge occur? burdensome debt. Relief
3. How does the debtor get a dis-
charge?
is attained through the
4. Are all the debtor’s debts discharged bankruptcy discharge, the
or only some?
5. Does the debtor have a right to a dis-
purpose of which is to
charge or can creditors object to the
discharge?
provide a “fresh start”
6. Can the debtor receive a second dis- to the honest debtor.
charge in a later chapter 7 case?
7. Can the discharge be revoked?

8. May the debtor pay a discharged

debt after the bankruptcy case has been
concluded?
9. What can the debtor do if a creditor
attempts to collect a discharged debt
after the case is concluded?

10. May an employer terminate a

debtor’s employment solely because the
person was a debtor or failed to repay
a discharged debt?
WHAT IS A DISCHARGE 11 plan. In cases under chapter 12
IN BANKRUPTCY? (adjustment of debts of a family
Under the federal bankruptcy statute, a farmer) and 13 (adjustment of debts of
discharge is a release of the debtor an individual with regular income), the
from personal liability for certain spec- court grants the discharge as soon as
ified types of debts. In other words, the practicable after the debtor completes
debtor is no longer required by law to all payments under the plan. Since a
pay any debts that are discharged. The chapter 12 or chapter 13 plan may pro-
discharge operates as a permanent vide for payments to be made over
order directed to the creditors of the three to five years, the discharge typi-
debtor that they refrain from taking cally occurs about four years after the
any form of collection action on dis- date of filing.
charged debts, including legal action
and communications with the debtor, HOW DOES THE DEBTOR
such as telephone calls, letters, and GET A DISCHARGE?
personal contacts. Unless there is litigation involving
Although a debtor is relieved of per- objections to the discharge, the debtor
sonal liability for all debts that are dis- will automatically receive a discharge.
charged, a valid lien (i.e., a charge upon The Federal Rules of Bankruptcy
specific property to secure payment of a Procedure provide for the clerk of the
debt) that has not been avoided (i.e., bankruptcy court to mail a copy of the
made unenforceable) in the bankruptcy order of discharge to all creditors, the
case will remain after the bankruptcy United States trustee, the trustee in the
case. Therefore, a secured creditor may case, and the trustee’s attorney, if any.
enforce the lien to recover the property The debtor and the debtor’s attorney
secured by the lien. also receive copies of the discharge
order. The notice, which is simply a
WHEN DOES THE copy of the final order of discharge, is
DISCHARGE OCCUR? not specific as to those debts deter-
The timing of the discharge varies, mined by the court to be non-dis-
depending on the chapter under which chargeable, i.e., not covered by the
the case is filed. In a chapter 7 (liquida- discharge. The notice informs credi-
tion) case, for example, the court usu- tors generally that the debts owed to
ally grants the discharge promptly on them have been discharged and that
expiration of the time fixed for filing a they should not attempt any further
complaint objecting to discharge and collection. They are cautioned in the
the time fixed for filing a motion to dis- notice that continuing collection
miss the case for substantial abuse (60 efforts could subject them to punish-
days following the first date set for the ment for contempt. Any inadvertent
341 meeting). Typically, this occurs failure on the part of the clerk to send
about four months after the date the the debtor or any creditor a copy of
debtor files the petition with the clerk the discharge order promptly within
of the bankruptcy court. In chapter 11 the time required by the rules does not
(reorganization) cases, the discharge affect the validity of the order grant-
occurs upon confirmation of a chapter ing the discharge.

6 • THE DISCHARGE IN BANKRUPTCY

ARE ALL OF THE DEBTOR’S
DEBTS DISCHARGED OR
ONLY SOME? Under the federal
Not all debts are discharged. The debts
discharged vary under each chapter of bankruptcy statute,
the Bankruptcy Code. Section 523(a) of
the Code specifically excepts various cat- a discharge is a
egories of debts from the discharge
granted to individual debtors. Therefore, release of the debtor
the debtor must still repay those debts
after bankruptcy. Congress has deter- from personal liability
mined that these types of debts are not
dischargeable for public policy reasons for certain specified
(based either on the nature of the debt or
the fact that the debts were incurred due types of debts. In
to improper behavior of the debtor, such
as the debtor’s drunken driving). other words, the
There are 18 categories of debt except-
ed from discharge under chapters 7, 11, debtor is no longer
and 12. A more limited list of exceptions
applies to cases under chapter 13. required by law to
Generally speaking, the exceptions to
discharge apply automatically if the lan- pay any debts that
guage prescribed by section 523(a)
applies. The most common types of are discharged.
non-dischargeable debts are certain
types of tax claims, debts not set forth
by the debtor on the lists and schedules a separation agreement or divorce
the debtor must file with the court, decree) are not automatically excepted
debts for spousal or child support or from discharge. Creditors must ask the
alimony, debts for willful and malicious court to determine that these debts are
injuries to person or property, debts to excepted from discharge. In the absence
governmental units for fines and penal- of an affirmative request by the creditor
ties, debts for most government funded and subsequent granting of the request
or guaranteed educational loans or ben- by the court, the types of debts set out in
efit overpayments, debts for personal sections 523(a)(2), (4), (6), and (15) will
injury caused by the debtor’s operation be discharged.
of a motor vehicle while intoxicated, A broader discharge of debts is avail-
and debts for certain condominium or able to a debtor in a chapter 13 case than
cooperative housing fees. in a chapter 7 case. As a general rule, the
The types of debts described in sec- chapter 13 debtor is discharged from all
tions 523(a)(2), (4), (6), and (15) (oblig- debts provided for by the plan except
ations affected by fraud or maliciousness certain long-term obligations (such as a
or certain debts incurred in connection home mortgage), debts for alimony or
with property settlements arising out of child support, debts for most govern-

THE DISCHARGE IN BANKRUPTCY • 7

 ment funded or guaranteed educational discharge is available only to a debtor
loans or benefit overpayments, debts whose failure to complete plan pay-
arising from death or personal injury ments is due to circumstances beyond the
caused by driving while intoxicated or debtor’s control.
under the influence of drugs, and debts The scope of a chapter 13 “hardship
for restitution or a criminal fine included discharge” is similar to that in a chap-
in a sentence on the debtor’s conviction ter 7 case with regard to the types of
of a crime. Although a chapter 13 debtor debts that are excepted from the dis-
charge. A hardship discharge also is
available in chapter 12 if the failure to
complete plan payments is due to “cir-
A governmental unit cumstances for which the debtor
should not justly be held accountable.”
or private employer
DOES THE DEBTOR
may not discriminate HAVE THE RIGHT TO A
DISCHARGE OR CAN
against a person CREDITORS OBJECT TO
THE DISCHARGE?
solely because the In chapter 7 cases, the debtor does not
have an absolute right to a discharge.
person was a debtor, An objection to the debtor’s discharge
may be filed by a creditor, by the trustee
was insolvent before in the case, or by the United States
trustee. Creditors receive a notice short-
or during the case, ly after the case is filed that sets forth
much important information, including
or has not paid the deadline for objecting to the dis-
charge. A creditor who desires to object
a debt that was to the debtor’s discharge must do so by
filing a complaint in the bankruptcy
discharged in court before the deadline set out in the
notice. Filing of a complaint starts a
the case. lawsuit referred to in bankruptcy as an
“adversary proceeding.” A chapter 7
discharge may be denied for any of the
reasons described in section 727(a) of
generally receives a discharge only after the Bankruptcy Code, including the
completing all payments required by the transfer or concealment of property
court-approved (i.e., “confirmed”) re- with intent to hinder, delay, or defraud
payment plan, there are some limited cir- creditors; destruction or concealment of
cumstances under which the debtor may books or records; perjury and other
request the court to grant a “hardship fraudulent acts; failure to account for
discharge” even though the debtor has the loss of assets; violation of a court
failed to complete plan payments. Such a order; or an earlier discharge in a chap-

8 • THE DISCHARGE IN BANKRUPTCY

ter 7 or 11 case commenced within six discharge in a chapter 7 case based on
years before the date the petition was allegations that the debtor obtained the
filed. If the issue of the debtor’s right to discharge fraudulently; the debtor failed
a discharge goes to trial, the objecting to disclose the fact that he or she
party has the burden of proving all the acquired or became entitled to acquire
facts essential to the objection. property that would constitute property
In chapter 12 and chapter 13 cases, of the bankruptcy estate; or the debtor
the debtor is entitled to a discharge committed one of several acts of impro-
upon completion of all payments under priety described in section 727(a)(6) of
the plan. The Bankruptcy Code does the Bankruptcy Code. Typically, a
not provide grounds for objecting to the request to revoke the debtor’s discharge
discharge of a chapter 12 or chapter 13 must be filed within one year after the
debtor. Creditors can object to confir- granting of the discharge or, in some
mation of the repayment plan, but can- cases, before the date that the case is
not object to the discharge if the debtor closed. It is up to the court to determine
has completed making plan payments. whether such allegations are true and, if
so, to revoke the discharge.
CAN A DEBTOR RECEIVE A In a chapter 13 case, if confirmation
SECOND DISCHARGE IN A of a plan or the discharge is obtained
LATER CHAPTER 7 CASE? through fraud, the court can revoke the
A discharge will be denied in a later order of confirmation or discharge.
chapter 7 case if the debtor has been
granted a discharge under chapter 7 or MAY THE DEBTOR PAY A
chapter 11 in a case filed within six years DISCHARGED DEBT AFTER
before the second petition is filed. The THE BANKRUPTCY CASE
debtor will also be denied a chapter 7 HAS BEEN CONCLUDED?
discharge if he or she previously was A debtor who has received a discharge
granted a discharge in a chapter 12 or may voluntarily repay any discharged
chapter 13 case filed within six years debt. A debtor may repay a discharged
before the date of the filing of the second debt even though it can no longer be
case unless (1) all the “allowed unse- legally enforced. Sometimes a debtor
cured” claims in the earlier case were agrees to repay a debt because it is
paid in full, or (2) payments under the owed to a family member or because it
plan in the earlier case totaled at least 70 represents an obligation to an individ-
percent of the allowed unsecured claims ual for whom the debtor’s reputation is
and the debtor’s plan was proposed in important, such as a family doctor.
good faith and the payments represented
the debtor’s best effort. WHAT CAN THE DEBTOR
DO IF A CREDITOR
CAN THE DISCHARGE ATTEMPTS TO COLLECT A
BE REVOKED? DISCHARGED DEBT AFTER
A discharge can be revoked under certain THE CASE IS CONCLUDED?
circumstances. For instance, a trustee, If a creditor attempts collection efforts
creditor, or the United States trustee may on a discharged debt, the debtor can
request that the court revoke the debtor’s file a motion with the court, reporting

THE DISCHARGE IN BANKRUPTCY • 9

the action and asking that the case be
reopened to address the matter. The
bankruptcy court will often do so to
ensure that the discharge is not violat-
ed. The discharge constitutes a perma-
nent statutory injunction prohibiting
creditors from taking any action,
including the filing of a lawsuit,
designed to collect a discharged debt. A
creditor can be sanctioned by the court
for violating the discharge injunction.
The normal sanction for violating the
discharge injunction is civil contempt,
which is often punishable by a fine.

CAN AN EMPLOYER
TERMINATE A DEBTOR’S
EMPLOYMENT SOLELY
BECAUSE THE PERSON
WAS A DEBTOR OR
FAILED TO REPAY A
DISCHARGED DEBT?
The law provides express prohibitions
against discriminatory treatment of
debtors by both governmental units and
private employers. A governmental unit
or private employer may not discrimi-
nate against a person solely because the
person was a debtor, was insolvent
before or during the case, or has not
paid a debt that was discharged in the
case. The law prohibits the following
forms of governmental discrimination:
terminating an employee; discriminat-
ing with respect to hiring; or denying,
revoking, suspending, or declining to
renew a license, franchise, or similar
privilege. A private employer may not
discriminate with respect to employ-
ment if the discrimination is based sole-
ly upon the bankruptcy filing.

10 • THE DISCHARGE IN BANKRUPTCY

 CHAPTER
Liquidation
Under the
Bankruptcy Code

ALTERNATIVES TO
CHAPTER 7
7
Chapter 7 of the United
Debtors should be aware that there are States Bankruptcy Code is
several alternatives to chapter 7 relief.
For example, debtors who are engaged the Bankruptcy Code’s
in business, including corporations,
partnerships, and sole proprietorships, “liquidation” chapter.
may prefer to remain in business and
avoid liquidation. Such debtors should Lawyers sometimes refer
consider filing a petition under chapter
11 of the Bankruptcy Code. Under chap- to it as a “straight
ter 11, the debtor may seek an adjust-
ment of debts, either by reducing the bankruptcy.” It is used
debt or by extending the time for repay-
ment, or may seek a more comprehen- primarily by individuals
sive reorganization. Sole proprietorships
may also be eligible for relief under who wish to free themselves
chapter 13 of the Bankruptcy Code.
In addition, individual debtors who of debt simply and
have regular income may seek an ad-
justment of debts under chapter 13 inexpensively, but may
of the Bankruptcy Code. Indeed, the
court may dismiss a chapter 7 case filed also be used by businesses
by an individual whose debts are pri-
marily consumer rather than business that wish to liquidate and
debts if the court finds that the granting
of relief would be a substantial abuse of terminate their business.
the provisions of chapter 7. 11 U.S.C.
§ 707(b). A number of courts have con-
cluded that a chapter 7 case may be dis-
missed for substantial abuse when the
debtor has the ability to propose and
carry out a workable and meaning-
ful chapter 13 plan.
Debtors should also be aware that
out-of-court agreements with creditors
or debt counseling services may provide One of the primary purposes of
an alternative to a bankruptcy filing. bankruptcy is to discharge certain debts
to give an honest individual debtor a
BACKGROUND “fresh start.” The discharge has the
The potential chapter 7 debtor should effect of extinguishing the debtor’s per-
understand that a straight bankruptcy sonal liability on dischargeable debts.
case does not involve the filing of In a chapter 7 case, however, a dis-
a plan of repayment as in chapter 13, charge is available to individual debtors
but rather envisions the bankruptcy only, not to partnerships or corpora-
trustee’s gathering and sale of the tions. 11 U.S.C. § 727(a)(1). Although
debtor’s nonexempt assets, from which the filing of an individual chapter 7
holders of claims (creditors) will receive petition usually results in a discharge of
distributions in accordance with the debts, an individual’s right to a dis-
provisions of the Bankruptcy Code. charge is not absolute, and some types
Part of the debtor’s property may be of debts are not discharged. Moreover,
subject to liens and mortgages that a bankruptcy discharge does not extin-
pledge the property to other creditors. guish a lien on property.
In addition, under chapter 7, the indi-
vidual debtor is permitted to retain cer- HOW CHAPTER 7 WORKS
tain “exempt” property. The debtor’s A chapter 7 case begins with the
remaining assets are liquidated by a debtor’s filing a petition with the bank-
trustee. Accordingly, potential debtors ruptcy court.1 The petition should be
should realize that the filing of a peti- filed with the bankruptcy court serving
tion under chapter 7 may result in the the area where the individual lives or
loss of property. where the business debtor has its prin-
In order to qualify for relief under cipal place of business or principal
chapter 7 of the Bankruptcy Code, the assets. 28 U.S.C. § 1408. In addition to
debtor must be an individual, a part- the petition, the debtor is also required
nership, or a corporation. 11 U.S.C. to file with the court several schedules
§§ 109(b); 101(41). Relief is available of assets and liabilities, a schedule of
under chapter 7 irrespective of the current income and expenditures, a
amount of the debtor’s debts or statement of financial affairs, and a
whether the debtor is solvent or insol- schedule of executory contracts and
vent. An individual cannot file under unexpired leases. Bankruptcy Rule
chapter 7 or any other chapter, howev- 1007(b). A husband and wife may file a
er, if during the preceding 180 days a joint petition or individual petitions.
prior bankruptcy petition was dis- 11 U.S.C. § 302(a). (Official Bank-
missed due to the debtor’s willful fail- ruptcy Forms can be purchased at a
ure to appear before the court or com- legal stationery store. They are not
ply with orders of the court or the available from the court.)
debtor voluntarily dismissed the previ- In order to complete the Official
ous case after creditors sought relief Bankruptcy Forms which make up the
from the bankruptcy court to recover petition and schedules, the debtor(s)
property upon which they hold liens. will need to compile the following
11 U.S.C. §§ 109(g), 362(d) and (e). information:

12 • LIQUIDATION UNDER THE BANKRUPTCY CODE

1. A list of all creditors and the amount against the debtor or the debtor’s prop-
and nature of their claims; erty. 11 U.S.C. § 362. This stay arises
by operation of law and requires no
2. The source, amount, and frequency judicial action. As long as the stay is in
of the debtor’s income; effect, creditors generally cannot initi-
ate or continue any lawsuits, wage gar-
3. A list of all of the debtor’s property; nishments, or even telephone calls
and demanding payments. Creditors nor-
mally receive notice of the filing of the
4. A detailed list of the debtor’s month- petition from the clerk.
ly living expenses, i.e., food, clothing, One of the schedules that will be
shelter, utilities, taxes, transportation, filed by the individual debtor is a
medicine, etc. schedule of “exempt” property. Federal
bankruptcy law provides that an indi-
Currently, the courts are required to vidual debtor2 can protect some prop-
charge a $155 case filing fee, a $30 mis- erty from the claims of creditors either
cellaneous administrative fee, and a because it is exempt under federal
$15 trustee surcharge (a total of $200). bankruptcy law or because it is exempt
The fees should be paid to the clerk of under the laws of the debtor’s home
the court upon filing or may, with the state. 11 U.S.C. § 522(b). Many states
court’s permission, be paid by individ- have taken advantage of a provision in
ual debtors in installments. 28 U.S.C. the bankruptcy law that permits each
§ 1930(a); Bankruptcy Rule 1006(b); state to adopt its own exemption law
Bankruptcy Court Miscellaneous Fee in place of the federal exemptions. In
Schedule, Item 8. Rule 1006(b) limits other jurisdictions, the individual
to four the number of installments for debtor has the option of choosing
the filing fee. The final installment shall between a federal package of exemp-
be payable not later than 120 days after tions or exemptions available under
filing the petition. For cause shown, the state law. Thus, whether certain prop-
court may extend the time of any erty is exempt and may be kept by the
installment, provided that the last debtor is often a question of state law.
installment is paid not later than 180 Legal counsel should be consulted to
days after the filing of the petition. determine the law of the state in which
Bankruptcy Rule 1006(b). The $30 the debtor lives.
administrative fee and the $15 trustee A “meeting of creditors” is usually
surcharge may be paid in installments held 20 to 40 days after the petition is
in the same manner as the filing fee. If filed. If the United States trustee or
a joint petition is filed, only one filing bankruptcy administrator3 designates
fee, one administrative fee, and one a place for the meeting that is not reg-
trustee surcharge are charged. Debtors ularly staffed by the United States
should be aware that failure to pay trustee or bankruptcy administrator,
these fees may result in dismissal of the the meeting may be held no more than
case. 11 U.S.C. § 707(a). 60 days after the order for relief.
The filing of a petition under chapter Bankruptcy Rule 2003(a). The debtor
7 “automatically stays” most actions must attend this meeting, at which

LIQUIDATION UNDER THE BANKRUPTCY CODE • 13

creditors may appear and ask questions the United States trustee (or by the court
regarding the debtor’s financial affairs in Alabama and North Carolina) to
and property. 11 U.S.C. § 343. If a hus- administer the case and liquidate the
band and wife have filed a joint peti- debtor’s nonexempt assets. 11 U.S.C.
tion, they both must attend the credi- §§ 701, 704. If, as is often the case, all
tors’ meeting. The trustee also will of the debtor’s assets are exempt or sub-
attend this meeting. It is important for ject to valid liens, there will be no distri-
the debtor to cooperate with the trustee bution to unsecured creditors. Typically,
and to provide any financial records or most chapter 7 cases involving individ-
documents that the trustee requests. ual debtors are “no asset” cases. If the
The trustee is required to examine the case appears to be an “asset” case at the
debtor orally at the meeting of creditors outset, however, unsecured creditors5
to ensure that the debtor is aware of the who have claims against the debtor must
potential consequences of seeking a dis- file their claims with the clerk of court
charge in bankruptcy, including the within 90 days after the first date set for
effect on credit history, the ability to the meeting of creditors. Bankruptcy
file a petition under a different chapter, Rule 3002(c). In the typical no asset
the effect of receiving a discharge, and chapter 7 case, there is no need for cred-
the effect of reaffirming a debt. In some itors to file proofs of claim. If the trustee
courts, trustees may provide written later recovers assets for distribution to
information on these topics at or in unsecured creditors, creditors will be
advance of the meeting, to ensure that given notice of that fact and additional
the debtor is aware of this information. time to file proofs of claim. Although
In order to preserve their independent secured creditors are not required to file
judgment, bankruptcy judges are pro- proofs of claim in chapter 7 cases in
hibited from attending the meeting of order to preserve their security interests
creditors. 11 U.S.C. § 341(c). or liens, there may be circumstances
In order to accord the debtor com- when it is desirable to do so. A creditor
plete relief, the Bankruptcy Code allows in a chapter 7 case who has a lien on the
the debtor to convert a chapter 7 case to debtor’s property should consult an
either a chapter 11 reorganization case attorney for advice.
or a case under chapter 13,4 as long as The commencement of a bankruptcy
the debtor meets the eligibility standards case creates an “estate.” The estate
under the chapter to which the debtor technically becomes the temporary legal
seeks to convert, and the case has not owner of all of the debtor’s property.
previously been converted to chapter 7 The estate consists of all legal or equi-
from either chapter 11 or chapter 13. table interests of the debtor in property
Thus, the debtor will not be permitted to as of the commencement of the case,
convert the case repeatedly from one including property owned or held by
chapter to another. 11 U.S.C. § 706(a). another person if the debtor has an
interest in the property. Generally
ROLE OF THE CASE speaking, the debtor’s creditors are paid
TRUSTEE from nonexempt property of the estate.
Upon the filing of the chapter 7 petition, The primary role of a chapter 7
an impartial case trustee is appointed by trustee in an “asset” case is to liquidate

14 • LIQUIDATION UNDER THE BANKRUPTCY CODE

the debtor’s nonexempt assets in a
manner that maximizes the return to
the debtor’s unsecured creditors. To Upon the filing of
accomplish this, the trustee attempts to
liquidate the debtor’s nonexempt prop- the chapter 7
erty, i.e., property that the debtor owns
free and clear of liens and the debtor’s petition, an impartial
property which has market value above
the amount of any security interest or case trustee is
lien and any exemption that the debtor
holds in the property. The trustee also appointed by the
pursues causes of action (lawsuits)
belonging to the debtor and pursues the United States trustee
trustee’s own causes of action to recov-
er money or property under the (or by the court
trustee’s “avoiding powers.” The
trustee’s avoiding powers include the in Alabama and
power to set aside preferential transfers
made to creditors within 90 days before North Carolina)
the petition, the power to undo securi-
ty interests and other prepetition trans- to administer the
fers of property that were not properly
perfected under nonbankruptcy law at case and liquidate
the time of the petition, and the power
to pursue nonbankruptcy claims such the debtor’s
as fraudulent conveyance and bulk
transfer remedies available under state nonexempt assets.
law. In addition, if the debtor is a busi-
ness, the bankruptcy court may autho-
rize the trustee to operate the debtor’s
business for a limited period of time, if which for some reason are not dis-
such operation will benefit the creditors chargeable in the bankruptcy case. The
of the estate and enhance the liquida- debtor’s major interests in a chapter 7
tion of the estate. 11 U.S.C. § 721. case are in retaining exempt property
The distribution of the property of and in getting a discharge that covers as
the estate is governed by section 726 of many debts as possible.
the Bankruptcy Code, which sets forth
the order of payment of all claims. DISCHARGE
Under section 726, there are six classes A discharge releases the debtor from per-
of claims, and each class must be paid sonal liability for discharged debts and
in full before the next lower class is prevents the creditors owed those debts
paid anything. The debtor is not partic- from taking any action against the
ularly interested in the trustee’s disposi- debtor or his property to collect the
tion of the estate assets, except with debts. The bankruptcy law regarding the
respect to the payment of those debts scope of a chapter 7 discharge is com-

LIQUIDATION UNDER THE BANKRUPTCY CODE • 15

plex, and debtors should consult compe- creditor promises that, as long as pay-
tent legal counsel in this regard prior to ments are made, the creditor will not
filing. As a general rule, however, repossess or take back the automobile
excluding cases which are dismissed or or other property. Because there is a
converted, individual debtors receive a disagreement among the courts con-
discharge in more than 99 percent of cerning whether a debtor whose debt is
chapter 7 cases. In most cases, unless a not in default may retain the property
complaint has been filed objecting to the and pay under the original contract
discharge or the debtor has filed a writ- terms without reaffirming the debt,
ten waiver, the discharge will be granted legal counsel should be consulted to
to a chapter 7 debtor relatively early in ensure that the debtor’s rights are pro-
the case, that is, 60 to 90 days after the tected and that any reaffirmation is in
date first set for the meeting of creditors. the debtor’s best interest.
Bankruptcy Rule 4004(c). If the debtor elects to reaffirm the
The grounds for denying an individ- debt, the reaffirmation should be accom-
ual debtor a discharge in a chapter 7 plished prior to the granting of a dis-
case are very narrow and are construed charge. A written agreement to reaffirm
against a creditor or trustee seeking to a debt must be filed with the court and,
deny the debtor a chapter 7 discharge. if the debtor is not represented by an
Among the grounds for denying a dis- attorney, must be approved by the judge.
charge to a chapter 7 debtor are that the 11 U.S.C. § 524(c). The Bankruptcy
debtor failed to keep or produce ade- Code requires that reaffirmation agree-
quate books or financial records; the ments contain an explicit statement
debtor failed to explain satisfactorily advising the debtor that the agreement is
any loss of assets; the debtor committed not required by bankruptcy or non-
a bankruptcy crime such as perjury; the bankruptcy law. In addition, the debtor’s
debtor failed to obey a lawful order of attorney is required to advise the debtor
the bankruptcy court; or the debtor of the legal effect and consequences of
fraudulently transferred, concealed, or such an agreement, including a default
destroyed property that would have under such an agreement. The Code
become property of the estate. 11 U.S.C. requires a reaffirmation hearing only if
§ 727; Bankruptcy Rule 4005. the debtor has not been represented by
In certain jurisdictions, secured cred- an attorney during the negotiating of the
itors may retain some rights to seize agreement. 11 U.S.C. § 524(d). The
pledged property, even after a discharge debtor may repay any debt voluntarily,
is granted. Depending on individual cir- however, whether or not a reaffirmation
cumstances, a debtor wishing to keep agreement exists. 11 U.S.C. § 524(f).
possession of the pledged property, Most claims against an individual
such as an automobile, may find it chapter 7 debtor are discharged. A cred-
advantageous to “reaffirm” the debt. A itor whose unsecured claim is discharged
reaffirmation is an agreement between may no longer initiate or continue any
the debtor and the creditor that the legal or other action against the debtor
debtor will pay all or a portion of the to collect the obligation. A discharge
money owed, even though the debtor under chapter 7, however, does not dis-
has filed bankruptcy. In return, the charge an individual debtor from certain

16 • LIQUIDATION UNDER THE BANKRUPTCY CODE

specific types of debts listed in section NOTES
523 of the Bankruptcy Code. Among the
1. An involuntary chapter 7 case may
types of debts which are not discharged
be commenced under certain circum-
in a chapter 7 case are alimony and child
stances by the filing of a petition by
maintenance and support obligations,
creditors holding claims against the
certain taxes, debts for certain educa-
debtor. 11 U.S.C. § 303.
tional benefit overpayments or loans
made or guaranteed by a governmental 2. Each debtor in a joint case (both hus-
unit, debts for willful and malicious band and wife) can claim exemptions
injury by the debtor to another entity or under the federal bankruptcy laws. 11
to the property of another entity, debts U.S.C. § 522(m).
for death or personal injury caused by
3. United States trustees and bankruptcy
the debtor’s operation of a motor vehicle
administrators are responsible for estab-
while the debtor was intoxicated from
lishing a panel of private trustees to
alcohol or other substances, and debts
serve as trustees in chapter 7 cases and
for criminal restitution orders under title
for supervising the administration of
18, United States Code. 11 U.S.C.
cases and trustees in cases under chap-
§ 523(a). To the extent that these types
ters 7, 11, 12, and 13 of the Bankruptcy
of debts are not fully paid in the chapter
Code. Bankruptcy administrators serve
7 case, the debtor is still responsible for
in the judicial districts in the states of
them after the bankruptcy case has con-
Alabama and North Carolina.
cluded. Debts for money or property
obtained by false pretenses, debts for 4. A fee of $400 is charged for convert-
fraud or defalcation while acting in a ing, on request of the debtor, a case
fiduciary capacity, debts for willful and under chapter 7 to a case under chapter
malicious injury by the debtor to anoth- 11. There is no fee for converting from
er entity or to the property of another chapter 7 to chapter 13.
entity, and debts arising from a property
5. Unsecured debts generally may be
settlement agreement incurred during or
defined as those for which the extension
in connection with a divorce or separa-
of credit was based purely upon an eval-
tion are discharged unless a creditor
uation by the creditor of the debtor’s
timely files and prevails in an action to
ability to pay, as opposed to secured
have such debts declared excepted from
debts, for which the extension of credit
the discharge. 11 U.S.C. § 523(c);
was based upon the creditor’s right to
Bankruptcy Rule 4007(c).
seize pledged property on default, in
The court may revoke a chapter 7
addition to the debtor’s ability to pay.
discharge on the request of the trustee,
a creditor, or the United States trustee if
the discharge was obtained through
fraud by the debtor or if the debtor
acquired property that is property of
the estate and knowingly and fraudu-
lently failed to report the acquisition of
such property or to surrender the prop-
erty to the trustee. 11 U.S.C. § 727(d).

LIQUIDATION UNDER THE BANKRUPTCY CODE • 17

CHAPTER

13
Chapter 13 of the
Individual Debt
Adjustment

BACKGROUND
Chapter 13 is designed for individuals
United States Bankruptcy with regular income who desire to pay
their debts but are currently unable to
Code is frequently referred do so. The purpose of chapter 13 is to
enable financially distressed individual
to as a “wage earner” debtors, under court supervision and
protection, to propose and carry out a
chapter, although it is repayment plan under which creditors
are paid over an extended period of
available to individuals time. Under this chapter, debtors are
permitted to repay creditors, in full or
with regular income in part, in installments over a three-
year period, during which time credi-
from any source, not tors are prohibited from starting or
continuing collection efforts. A plan
just wages. providing for payments over more
than three years must be “for cause”
and be approved by the court. In no
case may a plan provide for payments
over a period longer than five years.
11 U.S.C. § 1322(d).
Any individual, even if self-employed
or operating an unincorporated busi-
ness, is eligible for chapter 13 relief as
long as the individual’s unsecured debts
are less than $269,250 and secured
debts are less than $807,750. 11 U.S.C.
§ 109(e). A corporation or partnership
may not be a chapter 13 debtor. Id.
An individual cannot file under chap-
ter 13 or any other chapter if, during
the preceding 180 days, a prior bank-
ruptcy petition was dismissed due to
the debtor’s willful failure to appear
before the court or comply with orders
of the court or was voluntarily dis- In order to complete the Official
missed after creditors sought relief Bankruptcy Forms which make up the
from the bankruptcy court to recover petition, statement of financial affairs,
property upon which they hold liens. and schedules, the debtor will need to
11 U.S.C. §§ 109(g), 362(d) and (e). compile the following information:

HOW CHAPTER 13 WORKS 1. A list of all creditors and the

A chapter 13 case begins with the filing amounts and nature of their claims;
of a petition with the bankruptcy court
serving the area where the debtor has a 2. The source, amount, and frequency
domicile or residence. Unless the court of the debtor’s income;
orders otherwise, the debtor also shall
file with the court (1) schedules of 3. A list of all of the debtor’s property;
assets and liabilities, (2) a schedule of and
current income and expenditures, (3) a
schedule of executory contracts and 4. A detailed list of the debtor’s month-
unexpired leases, and (4) a statement of ly living expenses, i.e., food, clothing,
financial affairs. Bankruptcy Rule shelter, utilities, taxes, transportation,
1007(b). A husband and wife may file a medicine, etc.
joint petition or individual petitions.
11 U.S.C. § 302(a). (Official Bank- When a husband and wife file a joint
ruptcy Forms can be purchased at a petition or each spouse files an individ-
legal stationery store. They are not ual petition, the above detailed data
available from the court.) must be gathered for both spouses. So
Currently, the courts are required to that financial responsibilities can be
charge a $155 case filing fee and a $30 accurately assessed when only one
miscellaneous administrative fee. The spouse files, the income and expenses
fees should be paid to the clerk of the of the non-filing spouse should be
court upon filing or may, with the included in the debtor’s schedules and
court’s permission, be paid in install- statement of financial affairs.
ments. 28 U.S.C. § 1930(a); Bankrupt- Upon the filing of the petition, an
cy Rule 1006(b); Bankruptcy Court impartial trustee is appointed to admin-
Miscellaneous Fee Schedule, Item 8. ister the case. 11 U.S.C. § 1302. If the
Rule 1006(b) limits to four the number number of cases so warrants, the
of installments for the filing fee. The United States trustee may appoint a
final installment shall be payable not standing trustee to serve in all chapter
later than 120 days after filing the peti- 13 cases in a district. 28 U.S.C.
tion. For cause shown, the court may § 586(b). A primary role of the chapter
extend the time of any installment, 13 trustee is to serve as a disbursing
provided that the last installment is agent, collecting payments from
paid not later than 180 days after the debtors and making distributions to
filing of the petition. Bankruptcy Rule creditors. 11 U.S.C. § 1302.
1006(b). If a joint petition is filed, only The filing of the petition under chap-
one filing fee and one administrative ter 13 “automatically stays” most col-
fee are charged. lection actions against the debtor or

INDIVIDUAL DEBT ADJUSTMENT • 19

the debtor’s property. 11 U.S.C. § 362. such portion of the debtor’s future
As long as the “stay” is in effect, cred- income to the supervision of the trustee
itors generally cannot initiate or con- as is necessary for the execution of the
tinue any lawsuits, wage garnishment, plan. 11 U.S.C. § 1322. Other plan
or even telephone calls demanding provisions are permissive. Id. Plans,
payments. Creditors receive notice of which must be approved by the court,
the filing of the petition from the clerk provide for payments of fixed amounts
or the trustee. Further, chapter 13 con- to the trustee on a regular basis, typi-
tains a special automatic stay provision cally biweekly or monthly. The trustee
applicable to creditors. Specifically, then distributes the funds to creditors
after the commencement of a chapter according to the terms of the plan,
13 case, unless the bankruptcy court which may offer creditors less than full
authorizes otherwise, a creditor may payment on their claims. If the trustee
not seek to collect a “consumer debt” or a creditor with an unsecured claim2
from any individual who is liable with objects to confirmation of the plan, the
the debtor. 11 U.S.C. § 1301. Con- debtor is obligated to pay the amount
sumer debts are those incurred for con- of the claim or commit to the proposed
sumer, as opposed to business, needs. plan all projected “disposable income”
By virtue of the automatic stay, an during the period in which the plan is
individual debtor faced with a threat- in effect. 11 U.S.C. § 1325(b). Dispos-
ened foreclosure of the mortgage on his able income is defined as income not
or her principal residence can prevent reasonably necessary for the mainte-
an immediate foreclosure by filing a nance or support of the debtor or
chapter 13 petition. Chapter 13 then dependents. If the debtor operates a
affords the debtor a right to cure business, disposable income is defined
defaults on long-term home mortgage as excluding those amounts which
debts by bringing the payments current are necessary for the payment of ordi-
over a reasonable period of time. The nary operating expenses. 11 U.S.C.
debtor is permitted to cure a default § 1325(b)(2)(A) and (B).
with respect to a lien on the debtor’s A meeting of creditors is held in
principal residence up until the comple- every case, during which the debtor is
tion of a foreclosure sale under state examined under oath. It is usually held
law. 11 U.S.C. § 1322(c). 20 to 50 days after the petition is filed.
The debtor must file a plan of repay- If the United States trustee or bank-
ment with the petition or within fifteen ruptcy administrator3 designates a
days thereafter, unless extended by the place for the meeting which is not reg-
court for cause. Bankruptcy Rule 3015. ularly staffed by the United States
The chapter 13 plan must provide for trustee or bankruptcy administrator,
the full payment of all claims entitled to the meeting may be held no more than
priority under section 5071 (unless the 60 days after the order for relief.
holder of a particular claim agrees to Bankruptcy Rule 2003(a). The debtor
different treatment of the claim); if the must attend the meeting, at which cred-
plan classifies claims, provide the same itors may appear and ask questions
treatment for each claim within each regarding the debtor’s financial affairs
class; and provide for the submission of and the proposed terms of the plan.

20 • INDIVIDUAL DEBT ADJUSTMENT

11 U.S.C. § 343. If a husband and wife must start making payments to the
have filed a joint petition, they both trustee. 11 U.S.C. § 1326(a)(1). If the
must attend the creditors’ meeting. The plan is confirmed by the bankruptcy
trustee will also attend the meeting and judge, the chapter 13 trustee commences
question the debtor on the same mat- distribution of the funds received in
ters. In order to preserve their indepen- accordance with the plan “as soon as
dent judgment, bankruptcy judges are practicable.” 11 U.S.C. § 1326(a)(2). If
prohibited from attending. 11 U.S.C. the plan is not confirmed, the debtor has
§ 341(c). If there are problems with the a right to file a modified plan. 11 U.S.C.
plan, they are typically resolved during § 1323. The debtor also has a right to
or shortly after the creditors’ meeting. convert the case to a liquidation case
Generally, problems may be avoided if under chapter 7. 11 U.S.C. § 1307. If
the petition and plan are complete and the plan or modified plan is not con-
accurate and the trustee has been con- firmed and the case is dismissed, the
sulted prior to the meeting.
In a chapter 13 case, unsecured cred-
itors who have claims against the
debtor must file their claims with the If the number of
court within 90 days after the first date
set for the meeting of creditors. cases so warrants,
Bankruptcy Rule 3002(c). A govern-
mental unit, however, may file a proof the United States
of claim until the expiration of 180
days from the date the case is filed. trustee may appoint
11 U.S.C. § 502(b)(9).
After the meeting of creditors is con- a standing trustee
cluded, the bankruptcy judge must
determine at a confirmation hearing to serve in all
whether the plan is feasible and meets
the standards for confirmation set forth chapter 13 cases
in the Bankruptcy Code. 11 U.S.C.
§§ 1324 and 1325. Creditors, who will in a district.
receive 25 days’ notice of the hearing,
may object to confirmation. While a
variety of objections may be made, the
most frequent ones are that payments court may authorize the trustee to retain
offered under the plan are less than a specified amount for costs, but all
creditors would receive if the debtor’s other funds paid to the trustee are
assets were liquidated or that the returned to the debtor. 11 U.S.C.
debtor’s plan does not commit all of the § 1326(a)(2).
debtor’s projected disposable income On occasion, changed circumstances
for the three-year period of the plan. will affect a debtor’s ability to make
Within thirty days after the filing of plan payments, a creditor may object
the plan, even if the plan has not yet or threaten to object to a plan, or a
been approved by the court, the debtor debtor may inadvertently have failed

INDIVIDUAL DEBT ADJUSTMENT • 21

 ceed. The debtor must make regular
payments to the trustee, which will
Once the court require adjustment to living on a fixed
budget for a prolonged period. Alter-
confirms the plan, natively, the debtor’s employer can
withhold the amount of the payment
it is the responsibility from the debtor’s paycheck and trans-
mit it to the chapter 13 trustee.
of the debtor to Furthermore, while confirmation of the
plan entitles the debtor to retain prop-
make the plan erty as long as payments are made, the
debtor may not incur any significant
succeed. The debtor new credit obligations without consult-
ing the trustee, as such credit obliga-
must make regular tions may have an impact upon the
execution of the plan. 11 U.S.C.
payments to the §§ 1305(c), 1322(a)(1) & 1327.
A debtor may consent to the deduc-
trustee, which will tion of the plan payments from the
debtor’s paycheck. Experience has
require adjustment shown that this practice increases the
likelihood that payments will be made
to living on a fixed on time and that the plan will be com-
pleted. In any event, failure to make the
budget for a payments in accordance with the con-
firmed plan may result in dismissal of
prolonged period. the case or its conversion to a liquida-
tion case under chapter 7 of the
Bankruptcy Code. 11 U.S.C. § 1307(c).

to list all creditors. In such instances, THE CHAPTER 13

the plan may be modified either before DISCHARGE
or after confirmation. 11 U.S.C. The bankruptcy law regarding the
§§ 1323 & 1329. Modification after scope of the chapter 13 discharge is
confirmation is not limited to an initia- complex and has recently undergone
tive by the debtor, but may be at the major changes. Therefore, debtors
request of the trustee or an unsecured should consult competent legal counsel
creditor. 11 U.S.C. § 1329(a). prior to filing regarding the scope of
the chapter 13 discharge.
MAKING THE PLAN WORK The chapter 13 debtor is entitled to a
The provisions of a confirmed plan are discharge upon successful completion
binding on the debtor and each credi- of all payments under the chapter 13
tor. 11 U.S.C. § 1327. Once the court plan. 11 U.S.C. § 1328(a). The dis-
confirms the plan, it is the responsibili- charge has the effect of releasing the
ty of the debtor to make the plan suc- debtor from all debts provided for by

22 • INDIVIDUAL DEBT ADJUSTMENT

the plan or disallowed (under section creditors have received at least as much
502), with limited exceptions. Those as they would have received in a chap-
creditors who were provided for in full ter 7 liquidation case and when modifi-
or in part under the chapter 13 plan cation of the plan is not possible. Injury
may no longer initiate or continue any or illness that precludes employment
legal or other action against the debtor sufficient to fund even a modified plan
to collect the discharged obligations. may serve as the basis for a hardship
In return for the willingness of the discharge. The hardship discharge is
chapter 13 debtor to undergo the disci- more limited than the discharge
pline of a repayment plan for three to described above and does not apply to
five years, a broader discharge is avail- any debts that are nondischargeable in
able under chapter 13 than in a chapter a chapter 7 case. 11 U.S.C. § 523.
7 case. As a general rule, the debtor is
discharged from all debts provided for
NOTES
by the plan or disallowed, except cer-
tain long term obligations (such as a 1. Section 507 sets forth nine cate-
home mortgage), debts for alimony or gories of unsecured claims which
child support, debts for most govern- Congress has, for public policy reasons,
ment funded or guaranteed educational given priority of distribution over other
loans or benefit overpayments, debts unsecured claims.
arising from death or personal injury
2. Unsecured debts generally may be
caused by driving while intoxicated or
defined as those for which the exten-
under the influence of drugs, and debts
sion of credit was based purely upon an
for restitution or a criminal fine includ-
evaluation by the creditor of the
ed in a sentence on the debtor’s convic-
debtor’s ability to pay. In contrast,
tion of a crime. 11 U.S.C. § 1328(a). To
secured debts are those for which the
the extent that these types of debts are
extension of credit was based upon not
not fully paid pursuant to the chapter
only the creditor’s evaluation of the
13 plan, the debtor will still be respon-
debtor’s ability to pay, but upon the
sible for these debts after the bankrupt-
creditor’s right to seize pledged proper-
cy case has concluded.
ty on default.
THE CHAPTER 13 3. Bankruptcy Administrators, rather
HARDSHIP DISCHARGE than U.S. trustees, serve in the judicial
After confirmation of a plan, there are districts in the states of Alabama and
limited circumstances under which the North Carolina.
debtor may request the court to grant a
“hardship discharge” even though the
debtor has failed to complete plan pay-
ments. 11 U.S.C. § 1328(b). Generally,
such a discharge is available only to a
debtor whose failure to complete plan
payments is due to circumstances
beyond the debtor’s control and
through no fault of the debtor, after

INDIVIDUAL DEBT ADJUSTMENT • 23

CHAPTER

11
A case filed under
Reorganization
Under the
Bankruptcy Code

HOW CHAPTER 11 WORKS

A bankruptcy case commences when a
chapter 11 of the bankruptcy petition is filed with the
bankruptcy court. Fed. R. Bankr. P.
United States Bankruptcy 1002. A petition may be a voluntary
petition, which is filed by the debtor, or
Code is frequently referred it may be an involuntary petition, which
is filed by creditors that meet certain
to as a “reorganization” requirements. 11 U.S.C. §§ 301, 303.
A voluntary petition should adhere to
bankruptcy. the format of Form 1 of the Official
Forms prescribed by the Judicial
Conference of the United States. The
Official Forms may be purchased at
legal stationery stores or downloaded
from the Internet at [Link]/
bankform/. The voluntary petition will
include standard information concern-
ing the debtor’s name(s), social security
number or tax identification number,
residence, location of principal assets (if
a business), the debtor’s plan or inten-
tion to file a plan, and a request for
relief under the appropriate chapter of
the Bankruptcy Code. In addition, the
voluntary petition will indicate whether
the debtor qualifies as a small business
as defined in 11 U.S.C. § 101(51C) and
whether the debtor elects to be consid-
ered a small business under 11 U.S.C.
§ 1121(e).
Upon the filing of a voluntary peti-
tion for relief under chapter 11 or, in
an involuntary case, the entry of an
order for such relief, the debtor auto-
matically assumes an additional iden-
tity as the “debtor in possession.” tion hearing to determine whether to
11 U.S.C. § 1101. The term refers to confirm the plan. 11 U.S.C. § 1128.
a debtor that keeps possession and
control of its assets while undergoing THE CHAPTER 11 DEBTOR
a reorganization under chapter 11, IN POSSESSION
without the appointment of a case While individuals are not precluded
trustee. A debtor will remain a debtor from using chapter 11, it is more typi-
in possession until the debtor’s plan of cally used to reorganize a business,
reorganization is confirmed, the which may be a corporation, sole pro-
debtor’s case is dismissed or converted prietorship, or partnership. A corpora-
to chapter 7, or a chapter 11 trustee is tion exists separate and apart from its
appointed. The appointment or elec- owners, the stockholders. The chapter
tion of a trustee occurs only in a small 11 bankruptcy case of a corporation
number of cases. Generally, the (corporation as debtor) does not put the
debtor, as “debtor in possession,” personal assets of the stockholders at
operates the business and performs risk other than the value of their invest-
many of the functions that a trustee ment in the company’s stock. A sole
performs in cases under other chap- proprietorship (owner as debtor), on
ters. 11 U.S.C. § 1107(a). the other hand, does not have an identi-
A written disclosure statement and a ty separate and distinct from its
plan of reorganization must be filed owner(s); accordingly, a bankruptcy
with the court. 11 U.S.C. § 1121. The case involving a sole proprietorship
disclosure statement is a document includes both the business and personal
that must contain information con- assets of the owners-debtors. Like a cor-
cerning the assets, liabilities, and busi- poration, a partnership exists separate
ness affairs of the debtor sufficient to and apart from its partners. In a part-
enable a creditor to make an informed nership bankruptcy case (partnership as
judgment about the debtor’s plan of debtor), however, the partners’ personal
reorganization. 11 U.S.C. § 1125. The assets may, in some cases, be used to
information required is governed by pay creditors in the bankruptcy case or
judicial discretion and the circum- the partners may, themselves, be forced
stances of the case. The contents of the to file for bankruptcy protection.
plan must include a classification of Section 1107 of the Code places the
claims and must specify how each class debtor in possession in the position of a
of claims will be treated under the fiduciary, with the rights and powers of
plan. 11 U.S.C. § 1123. Creditors a chapter 11 trustee, and requires the
whose claims are “impaired,” i.e., performance of all but the investigative
those whose contractual rights are to functions and duties of a trustee. These
be modified or who will be paid less duties are set forth in the Bankruptcy
than the full value of their claims Code and Federal Rules of Bankruptcy
under the plan vote on the plan by bal- Procedure. 11 U.S.C. §§ 1106, 1107;
lot. 11 U.S.C. § 1126. After the disclo- Fed. R. Bankr. P. 2015(a). Such powers
sure statement is approved and the bal- and duties include accounting for prop-
lots are collected and tallied, the bank- erty, examining and objecting to claims,
ruptcy court will conduct a confirma- and filing informational reports as

REORGANIZATION UNDER THE BANKRUPTCY CODE • 25

required by the court and the United in a small business case. 11 U.S.C.
States trustee, such as monthly operat- § 1102(a)(3). A small business case
ing reports. The debtor in possession proceeds faster than a regular chapter
also has many of the other powers and 11 case because the court may condi-
duties of a trustee including the right, tionally approve a disclosure statement,
with the court’s approval, to employ subject to final approval after notice
attorneys, accountants, appraisers, auc- and a hearing and solicitation of votes
tioneers, or other professional persons for acceptance or rejection of the plan.
to assist the debtor during its bank- Thereafter, the disclosure statement
ruptcy case. Other responsibilities hearing may be combined with the con-
include filing tax returns and filing such firmation hearing. 11 U.S.C. § 1125(f).
reports as are necessary or as the court In addition, the debtor has a shortened
orders after confirmation, such as a period of time (100 days from the date
final accounting. The United States of the order for relief) within which
trustee is responsible for monitoring only the debtor may file a plan. After
the compliance of the debtor in posses- the 100-day period expires, any party
sion with the reporting requirements. in interest may file a plan; however, all
It should be noted that railroad reor- plans must be filed within 160 days
ganizations have specific requirements from the date of the order for relief.
under subsection IV of chapter 11 11 U.S.C. § 1121(e).
which will not be addressed here and
that stock and commodity brokers are THE SINGLE ASSET REAL
prohibited from filing under chapter 11 ESTATE DEBTOR
and are restricted to chapter 7. Another type of debtor that has special
11 U.S.C. § 109(d). provisions under the Bankruptcy Code
is a single asset real estate debtor. The
THE SMALL BUSINESS term “single asset real estate” is
DEBTOR defined as “a single property or pro-
A small business debtor is defined by ject, other than residential real proper-
the Bankruptcy Code as a person ty with fewer than four residential
engaged in commercial or business units, which generates substantially all
activities (not including a person that of the gross income of a debtor and on
primarily owns or operates real proper- which no substantial business is being
ty) that has aggregate noncontingent conducted by a debtor” other than
liquidated secured and unsecured debts operating the real property and which
that do not exceed $2,000,000. has aggregate noncontingent liquidat-
11 U.S.C. § 101(51C). If a debtor qual- ed secured debts of no more than
ifies and elects to be considered a small $4,000,000. 11 U.S.C. § 101(51B).
business under 11 U.S.C. § 1121(e), the The Bankruptcy Code provides cir-
case is put on a “fast track” and treat- cumstances under which creditors of a
ed differently than a regular chapter 11 single asset real estate debtor may
case under the Code. For example, the obtain relief from the automatic stay
appointment of a creditors’ committee which are not available to creditors in
and a separate hearing to approve the ordinary bankruptcy cases. 11 U.S.C.
disclosure statement are not mandatory § 362(d). On request of a creditor with

26 • REORGANIZATION UNDER THE BANKRUPTCY CODE

a claim secured by the single asset real
estate and after notice and a hearing,
the court will grant relief from the While individuals are
automatic stay to the creditor unless
the debtor files a feasible plan of re- not precluded from
organization or begins making interest
payments to the creditor within 90 using chapter 11,
days from the date of the order for
relief. The interest payments must it is more typically
be equal to the current fair market
interest rate on the value of the credi- used to reorganize a
tor’s interest in the real estate.
11 U.S.C. § 362(d)(3). business, which may
THE AUTOMATIC STAY be a corporation,
The automatic stay provides for a
period of time in which all judgments, sole proprietorship,
collection activities, foreclosures, and
repossessions of property are suspend- or partnership.
ed and may not be pursued by the
creditors on any debt or claim that
arose before the filing of the bank-
ruptcy petition. As with cases under foreclose on the property, sell it, and
other chapters of the Bankruptcy apply the proceeds to the debt.
Code, a stay of creditor actions 11 U.S.C. § 362(d).
against the debtor automatically goes It should be noted that, although
into effect when the bankruptcy peti- creditors are stayed from action
tion is filed. 11 U.S.C. § 362(a). The against the debtor unless relief is grant-
filing of a petition, however, does not ed by the court, section 331 of the
operate as a stay for certain types Bankruptcy Code permits applications
of actions listed under 11 U.S.C. for fees to be made by certain profes-
§ 362(b). The stay provides a breath- sionals during the case. Thus, a trustee,
ing spell for the debtor, during which a debtor’s attorney, or any professional
negotiations can take place to try to person appointed by the court may
resolve the difficulties in the debtor’s apply to the court at intervals of 120
financial situation. days for interim compensation and
Under specific circumstances, the reimbursement payments. In very large
secured creditor can obtain an order cases with extensive legal work the
from the court granting relief from the court may permit more frequent appli-
automatic stay. For example, when the cations. Although professional fees
debtor has no equity in the property may be paid pursuant to authorization
and that property is not necessary for by the court, the debtor cannot make
an effective reorganization, the secured payments to professional creditors on
creditor can seek an order of the court prepetition obligations, i.e., obliga-
lifting the stay to permit the creditor to tions which arose before the filing of

REORGANIZATION UNDER THE BANKRUPTCY CODE • 27

the bankruptcy petition. The ordinary States trustee, the committee, or anoth-
expenses of the ongoing business, how- er party in interest acts to ensure the
ever, continue to be paid. case’s timely resolution. The creditors’
right to file a competing plan provides
CREDITORS’ COMMITTEES incentive for the debtor to file a plan
Creditors’ committees can play a within the exclusive period and acts as
major role in chapter 11 cases. The a check on excessive delay in the case.
United States trustee, a federal employ-
ee to be distinguished from a private AVOIDABLE TRANSFERS
case trustee or panel trustee, appoints The debtor in possession or the trustee,
the committee, which ordinarily con- as the case may be, has what are called
sists of unsecured creditors who hold “avoiding” powers. Such powers may
the seven largest unsecured claims be used to undo a transfer of money or
against the debtor. 11 U.S.C. § 1102. property made during a certain period
The committee may consult with the of time prior to the filing of the bank-
debtor in possession on the administra- ruptcy petition. By avoiding a particu-
tion of the case, investigate the conduct lar transfer of property, the debtor in
of the debtor and the operation of the possession can cancel the transaction
business, and participate in the formu- and force the return or “disgorgement”
lation of a plan. 11 U.S.C. § 1103. A of the payments or property, which
creditors’ committee may, with the then are available to pay all creditors.
court’s approval, hire an attorney or Generally, the power to avoid transfers
other professionals to assist in the per- is effective against transfers made with-
formance of the committee’s duties. A in 90 days prior to the filing of the peti-
creditors’ committee can be an impor- tion. However, transfers to insiders (i.e.,
tant safeguard to the proper manage- relatives, general partners, and direc-
ment of the business by the debtor in tors or officers of the debtor) made up
possession. to a year prior to filing can be avoided.
11 U.S.C. §§ 101(31), 101(54), 547,
WHO CAN FILE A PLAN 548. In addition, under 11 U.S.C.
There is no specific statutory time limit § 544, the trustee is given the authority
set for the filing of a plan; however, the to avoid transfers under applicable state
debtor (unless a “small business” law, which often provides for longer
debtor, as set out above) has a 120-day time periods. Avoiding powers are used,
period during which it has an exclusive for example, to prevent unfair prepeti-
right to file a plan. 11 U.S.C. tion payments to one creditor at the
§ 1121(b). The debtor’s exclusive peri- expense of all other creditors.
od in which to file a plan may be
extended or reduced by the court. After CASH COLLATERAL,
the exclusive period has expired, a cred- ADEQUATE PROTECTION,
itor or the case trustee may file a com- AND OPERATING CAPITAL
peting plan. The United States trustee Although the preparation, confirma-
may not file a plan. 11 U.S.C. § 307. tion, and implementation of a plan of
A chapter 11 case may continue for reorganization is at the heart of a chap-
many years unless the court, the United ter 11 case, other issues may arise

28 • REORGANIZATION UNDER THE BANKRUPTCY CODE

which must be addressed by the debtor session. 11 U.S.C. § 363(c)(4). A party
in possession. The debtor in possession with an interest in property being used
may use, sell, or lease property of the by the debtor may request that the
estate in the ordinary course of its busi- court prohibit or condition this use to
ness, without prior approval, unless the extent necessary to provide “ade-
the court orders otherwise. 11 U.S.C. quate protection” to the creditor.
§ 363(c). If the intended sale or use is Adequate protection may be required
outside the ordinary course of its busi- to protect the value of the creditor’s
ness, the debtor must obtain permission interest in the property being used by
from the court. A debtor in possession the debtor in possession. This is espe-
may not use “cash collateral,” i.e., col- cially important when there is a
lections of accounts subject to security decrease in value of the property. The
interests or proceeds from the sale of debtor may make periodic or lump sum
pledged inventory or equipment, with- cash payments, or provide an addition-
out the consent of the secured party or al or replacement lien that will result in
authorization by the court which must the creditor’s property interest being
first examine whether the interest of the adequately protected. 11 U.S.C. § 361.
secured party is adequately protected. When a chapter 11 debtor needs
11 U.S.C. § 363. operating capital, it may be able to
When “cash collateral” is used obtain it from a lender by giving the
(spent), the secured creditors are enti- lender a court-approved “superpriori-
tled to receive additional protection ty” over other unsecured creditors or
under section 363 of the Bankruptcy a lien on property of the estate.
Code. Section 363 defines “cash collat- 11 U.S.C. § 364.
eral” as cash, negotiable instruments,
documents of title, securities, deposit APPOINTMENT OR
accounts, or other cash equivalents, ELECTION OF A CASE
whenever acquired, in which the estate TRUSTEE
and an entity other than the estate have Although the appointment of a case
an interest. It includes the proceeds, trustee is a rarity in a chapter 11 case,
products, offspring, rents, or profits of a party in interest or the United States
property and the fees, charges, trustee can request the appointment of
accounts or payments for the use or a case trustee or examiner at any time
occupancy of rooms and other public prior to confirmation in a chapter 11
facilities in hotels, motels, or other case. The court, on motion by a party
lodging properties subject to a credi- in interest or the United States trustee
tor’s security interest. The debtor in and after notice and hearing, shall
possession must file a motion request- order the appointment of a case
ing an order from the court authorizing trustee for cause, including fraud,
the use of the cash collateral. Pending dishonesty, incompetence, or gross
consent of the secured creditor or court mismanagement, or if such an
authorization for the debtor in posses- appointment is in the interest of credi-
sion’s use of cash collateral, the debtor tors, any equity security holders, and
in possession must segregate and other interests of the estate. 11 U.S.C.
account for all cash collateral in its pos- § 1104(a). The trustee is appointed by

REORGANIZATION UNDER THE BANKRUPTCY CODE • 29

 the United States trustee, after consul- ness, and, if appropriate, the filing of
tation with parties in interest and sub- a plan of reorganization. Section 1106
ject to the court’s approval. Fed. R. of the Code requires the trustee to file
Bankr. P. 2007.1. Alternatively, a a plan “as soon as practicable” or,
trustee in a case may be elected if a alternatively, to file a report explain-
party in interest requests the election ing why a plan will not be filed or
of a trustee within 30 days after the to recommend that the case be con-
court orders the appointment of a verted to another chapter or dis-
trustee. In that instance, the United missed. 11 U.S.C. § 1106(a)(5).
The court, after notice and hearing,
may, at any time before confirmation,
upon the request of a party in interest
Although the or the United States trustee, terminate
the trustee’s appointment and restore
appointment of a the debtor to possession and manage-
ment of the property of the estate and
case trustee is a rarity of the operation of the debtor’s busi-
ness. 11 U.S.C. § 1105.
in a chapter 11 case,
THE ROLE OF AN
a party in interest or EXAMINER
The appointment of an examiner in a
the United States chapter 11 case is rare. The role of an
examiner is generally more limited
trustee can request than that of a trustee. The examiner is
authorized to perform the investigato-
the appointment of ry functions of the trustee and is
required to file a statement of any
a case trustee or investigation conducted. If ordered to
do so by the court, however, an exam-
examiner at any time iner may carry out any other duties of
a trustee that the court orders the
prior to confirmation debtor in possession not to perform.
11 U.S.C. § 1106. Each court has the
in a chapter 11 case. authority to determine the duties of an
examiner in each particular case. In
some cases, the examiner may file a
plan of reorganization, negotiate or
States trustee convenes a meeting of help the parties negotiate, or review
creditors for the purpose of electing a the debtor’s schedules to determine
person to serve as trustee in the case. whether some of the claims are
11 U.S.C. § 1104(b). improperly categorized. Sometimes,
The case trustee is responsible for the examiner may be directed to deter-
management of the property of the mine if objections to any proofs of
estate, operation of the debtor’s busi- claim should be filed or whether caus-

30 • REORGANIZATION UNDER THE BANKRUPTCY CODE

es of action have sufficient merit so amount of the fee, which may range
that further legal action should be from $250 to $10,000, depends upon
taken. An examiner may not serve as a the amount of the debtor’s disburse-
trustee. 11 U.S.C. § 321. ments during each quarter. Should a
debtor in possession fail to comply with
THE UNITED STATES the reporting requirements of the
TRUSTEE OR BANKRUPTCY United States trustee or orders of the
ADMINISTRATOR bankruptcy court or fail to take the
In addition to the case trustee or exam- appropriate steps to bring the case to
iner and the creditors’ committee, the confirmation, the United States trustee
United States trustee plays a major role may file a motion with the court to have
in monitoring the progress of a chapter the debtor’s chapter 11 case converted
11 case and supervising its administra- to a case under another chapter of the
tion. The United States trustee is Code or to have the case dismissed.
responsible for monitoring the debtor It should be noted that in North
in possession’s operation of the busi- Carolina and Alabama, bankruptcy
ness, and the submission of operating administrators perform similar func-
reports and fees. Additionally, the U.S. tions that United States trustees per-
Trustee monitors applications for com- form in the remaining forty-eight
pensation and reimbursement by pro- states. The bankruptcy administrator
fessionals, plans and disclosure state- program is administered by the
ments filed with the court, and credi- Administrative Office of the United
tors’ committees. The United States States Courts, while the United States
trustee conducts a meeting of the cred- trustee program is administered by the
itors, often referred to as the “section Department of Justice. For purposes of
341 meeting,” in a chapter 11 case. 11 this fact sheet, references to United
U.S.C. § 341. The United States trustee States trustees are also applicable to
and creditors may question the debtor bankruptcy administrators.
or the debtor’s corporate representa-
tive under oath at the section 341 MOTIONS
meeting concerning the debtor’s acts, Prior to confirmation of a plan, there
conduct, property, and the administra- are several activities that may take
tion of the case. place in a chapter 11 case. The contin-
The United States trustee also impos- ued operation of the debtor’s business
es certain requirements on the debtor in may lead to the filing of a number of
possession concerning matters such as contested motions. The most common
reporting its monthly income and oper- are those seeking relief from the auto-
ating expenses, the establishment of matic stay, the use of cash collateral, or
new bank accounts, and the payment of to obtain credit. There may also be liti-
current employee withholding and gation over executory (i.e., unfulfilled)
other taxes. By law, the debtor in pos- contracts and unexpired leases and the
session must pay a quarterly fee to the assumption or rejection of those execu-
United States trustee for each quarter of tory contracts and unexpired leases
a year until the case is converted or dis- by the debtor in possession. 11 U.S.C.
missed. 28 U.S.C. § 1930(a)(6). The § 365. Delays in formulating, filing,

REORGANIZATION UNDER THE BANKRUPTCY CODE • 31

and obtaining confirmation of a plan the case is pending. The clerk is
often cause creditors to file motions for required to keep a list of claims filed in
relief from stay or motions to convert a case when it appears that there will be
the case to a chapter 7 or to dismiss the a distribution to unsecured creditors.
case altogether. Fed. R. Bankr. P. 5003(b). Most credi-
tors whose claims are scheduled (i.e.,
ADVERSARY claims listed by the debtor on the
PROCEEDINGS debtor’s schedules), but not listed as
Frequently, the debtor in possession will disputed, contingent, or unliquidated,
institute a lawsuit, known as an adver- need not file claims because the sched-
sary proceeding, to recover money or ule of liabilities is deemed to constitute
property for the estate. Adversary pro- evidence of the validity and amount of
ceedings may take the form of lien those claims. 11 U.S.C. § 1111. Any
avoidance actions, actions to avoid creditor whose claim is not scheduled,
preferences, actions to avoid fraudulent or is scheduled as disputed, contingent,
transfers, or actions to avoid post peti- or unliquidated, must file a proof of
tion transfers. Such proceedings are claim in order to be treated as a credi-
governed by Part VII of the Federal tor for purposes of voting on the plan
Rules of Bankruptcy Procedure. At and distribution under it. Fed. R.
times, a creditors’ committee may be Bankr. P. 3003(c)(2). If a scheduled
authorized by the bankruptcy court to creditor chooses to file a claim, a prop-
pursue these actions against insiders of erly filed proof of claim supersedes any
the debtor if the plan provides for the scheduling of that claim. Fed. R. Bankr.
committee to do so or if the debtor has P. 3003(c)(4). It is the responsibility of
refused a demand to do so. Creditors the creditor to determine whether the
may also initiate adversary proceedings claim is accurately listed. The debtor
by filing complaints to determine the must provide notification to those cred-
validity or priority of a lien, to revoke itors whose names are added and
an order confirming a plan, to deter- whose claims are listed as a result of an
mine the dischargeability of a debt, to amendment to the schedules. The noti-
obtain an injunction, or to subordinate fication also should advise such credi-
a claim of another creditor. tors of their right to file proofs of claim
and that their failure to do so may pre-
CLAIMS vent them from voting upon the
A claim is a right to payment or a right debtor’s plan of reorganization or par-
to an equitable remedy for a failure of ticipating in any distribution under that
performance if the breach gives rise to a plan. When a debtor amends the sched-
right to payment. 11 U.S.C. § 101(5). ule of liabilities to add a creditor or
In some instances, a creditor must file a change the status of any claims to dis-
proof of claim form along with docu- puted, contingent, or unliquidated
mentation evidencing the validity and claims, the debtor must provide notice
amount of the claim. When proofs of of the amendment to any entity affect-
claim are required to be filed, creditors ed. Fed. R. Bankr. P. 1009(a).
must file the proofs of claim with the
bankruptcy clerk in the district where

32 • REORGANIZATION UNDER THE BANKRUPTCY CODE

EQUITY SECURITY does not have an absolute right to have
HOLDERS the case dismissed upon request.
An equity security holder is a holder of Generally, upon the request of a party
an equity security of the debtor. in interest in the case or the United
Examples of an equity security are a States trustee, after notice and hearing
share in a corporation, an interest of a and “for cause,” the court may convert
limited partner in a limited partnership, a chapter 11 case to a case under chap-
or a right to purchase, sell, or subscribe ter 7 or dismiss the case, whichever is in
to a share, security, or interest of a share the best interest of creditors and the
in a corporation or an interest in a lim- estate. 11 U.S.C. § 1112(b). The court
ited partnership. 11 U.S.C §§ 101(16) , may convert or dismiss a case “for
(17). An equity security holder may vote cause” when there is a continuing loss
on the plan of reorganization and may to the estate, an inability to effectuate a
file a proof of interest, rather than a plan, unreasonable delay that is prejudi-
proof of claim. A proof of interest is cial to creditors, denial or revocation of
deemed filed for any interest that confirmation, or inability to consum-
appears in the debtor’s schedules, unless mate a confirmed plan.
it is scheduled as disputed, contingent, There are important exceptions to
or unliquidated. 11 U.S.C. § 1111. An the conversion process in a chapter 11
equity security holder whose interest is case. One exception is that, unless the
not scheduled or scheduled as disputed, debtor requests the conversion, section
contingent, or unliquidated must file a 1112(c) of the Code prohibits the court
proof of interest in order to be treated from converting a case involving a
as a creditor for purposes of voting on farmer or charitable institution to a liq-
the plan and distribution under it. Fed. uidation case under chapter 7.
R. Bankr. P. 3003(c)(2). A properly filed
proof of interest supersedes any sched- THE DISCLOSURE
uling of that interest. Fed. R. Bankr. P. STATEMENT
3003(c)(4). Generally, most of the pro- The filing of a written disclosure state-
visions that apply to proofs of claim, as ment is preliminary to the voting on a
discussed above, are also applicable to plan of reorganization, and the disclo-
proofs of interest. sure statement must provide “adequate
information” concerning the affairs of
CONVERSION OR the debtor to enable the holder of a
DISMISSAL claim or interest to make an informed
A debtor in a case under chapter 11 has judgment about the plan. 11 U.S.C.
a one-time absolute right to convert the § 1125. After the disclosure statement is
chapter 11 case to a case under chapter 7 filed, the court must hold a hearing to
unless (1) the debtor is not a debtor in determine whether the disclosure state-
possession, (2) the case originally was ment should be approved. Acceptance
commenced as an involuntary case under or rejection of a plan cannot be solicit-
chapter 11, or (3) the case was converted ed without prior court approval of the
to a case under chapter 11 other than written disclosure statement. 11 U.S.C.
at the debtor’s request. 11 U.S.C. § 1125(b). After the disclosure state-
§ 1112(a). A debtor in a chapter 11 case ment has been approved, the debtor or

REORGANIZATION UNDER THE BANKRUPTCY CODE • 33

proponent of a plan can begin to solicit menced by an involuntary petition, after
acceptances of the plan, and creditors the order for relief) to obtain accep-
may also solicit rejections of the plan. tances of the plan. 11 U.S.C. § 1121.
Fed. R. Bankr. P. 3017(d) requires that, For cause, the court may extend or
upon approval of a disclosure state- reduce this exclusive period. 11 U.S.C.
ment, the following must be mailed to § 1121(d). The exclusive right of the
the United States trustee and all credi- debtor in possession to file a plan is lost
tors and equity security holders: (1) the and any party in interest, including the
plan, or a court approved summary of debtor, may file a plan if and only if (1)
the plan; (2) the disclosure statement a trustee has been appointed in the case,
approved by the court; (3) notice of the (2) the debtor has not filed a plan with-
time within which acceptances and in the 120-day exclusive period or any
rejections of the plan may be filed; and extension granted by the court, or (3)
(4) such other information as the court the debtor has not filed a plan which
may direct, including any opinion of the has been accepted by each class of
court approving the disclosure state- claims or interests that is impaired
ment or a court-approved summary of under the plan within the 180-day peri-
the opinion. Fed. R. Bankr. P. 3017(d). od or any extensions granted by the
In addition, the debtor must mail to the court. 11 U.S.C. § 1121.
creditors and equity security holders If the exclusive period expires before
entitled to vote on the plan or plans (1) the debtor has filed and obtained
notice of the time fixed for filing objec- acceptance of a plan, other parties in
tions; (2) notice of the date and time for interest in a case, such as the creditors’
the hearing on confirmation of the plan; committee or a creditor, may file a
and (3) a ballot for accepting or reject- plan. Such a plan may compete with a
ing the plan and, if appropriate, a desig- plan filed by another party in interest
nation for the creditors to identify their or by the debtor. If a trustee is appoint-
preference among competing plans. Id. ed, the trustee is responsible for filing a
However, in a small business case, the plan, a report of why the trustee will
court may conditionally approve a dis- not file a plan, or a recommendation
closure statement subject to final for the conversion or dismissal of the
approval after notice and a combined case. 11 U.S.C. § 1106(a)(5). A propo-
disclosure statement/plan confirmation nent of a plan is subject to the same
hearing. 11 U.S.C. § 1125(F). requirements as the debtor with respect
to disclosure and solicitation.
ACCEPTANCE OF THE PLAN It should be noted that, in a chapter
OF REORGANIZATION 11 case, a liquidating plan is permissi-
As noted earlier, during the first 120- ble. Such a plan often allows the debtor
day period after the filing of the volun- in possession to liquidate the business
tary bankruptcy petition, which filing under more economically advanta-
also acts as the order of relief, only the geous circumstances than a chapter 7
debtor in possession may file a plan of liquidation. It also permits the creditors
reorganization. The debtor in posses- to take a more active role in fashioning
sion has 180 days after the filing of the the liquidation of the assets and the
voluntary petition (or in a case com-

34 • REORGANIZATION UNDER THE BANKRUPTCY CODE

distribution of the proceeds than in a the modification in writing, the modi-
chapter 7 case. fication shall be deemed to have been
Section 1123(a) of the Bankruptcy accepted by all creditors who previous-
Code lists the mandatory provisions of ly accepted the plan. If it is determined
a chapter 11 plan and section 1123(b) that the proposed modification does
lists the discretionary provisions. have an adverse effect on the claims of
Section 1123(a)(1) provides that a nonconsenting creditors, then another
chapter 11 plan shall designate classes balloting must take place.
of claims and interests for treatment
under the reorganization. Generally, a
plan will classify claim holders as
secured creditors, unsecured creditors In a chapter 11
entitled to priority, general unsecured
creditors, and equity security holders. case, a liquidating
Under section 1126(c) of the Code,
an entire class of claims accepts a plan plan is permissible.
if the plan is accepted by creditors that
hold at least two-thirds in amount and Such a plan often
more than one-half in number of the
allowed claims in the class. Under sec- allows the debtor
tion 1129(a)(10), if there are impaired
classes of claims, the court cannot con- in possession to
firm a plan unless the plan has been
accepted by at least one class of non- liquidate the
insiders who hold impaired claims.
“Impaired” claims are claims that are business under
not going to be paid completely or in
which some legal, equitable, or con- more economically
tractual right is altered. Moreover,
under section 1126(f), holders of unim- advantageous
paired claims are deemed to have
accepted the plan. circumstances
Under section 1127(a) of the
Bankruptcy Code, the proponent may than a chapter 7
modify the plan at any time before
confirmation, but the plan as modified liquidation.
must meet all the requirements of
chapter 11. Federal Rule of
Bankruptcy Procedure 3019 provides
that, when there is a proposed modifi- Because more than one plan may
cation after balloting has been con- be submitted to the creditors for
ducted and the court finds after a hear- approval, Federal Rule of Bankruptcy
ing that the proposed modification Procedure 3016(a) requires that every
does not adversely affect the treatment proposed plan and modification
of any creditor who has not accepted be dated and identified with the name

REORGANIZATION UNDER THE BANKRUPTCY CODE • 35

 law. Fed. R. Bankr. P. 3020(b)(2).
Before confirmation can be granted, the
Confirmation of a court must be satisfied that there has
been compliance with all the other
plan discharges the requirements of confirmation set forth
in section 1129 of the Code, even in the
debtor from any debt absence of any objections. In order to
confirm the plan, the court must find
that arose before the that (1) the plan is feasible, (2) it is pro-
posed in good faith, and (3) the plan
date of confirmation. and the proponent of the plan are in
compliance with the Code. In addition,
After the plan is the court must find that confirmation
of the plan is not likely to be followed
confirmed, the debtor by liquidation or the need for further
financial reorganization.
is required to make
THE DISCHARGE
plan payments and While some courts have a practice of
issuing a discharge order in a case
is bound by the involving an individual, a separate
order of discharge is usually not
provisions of the plan entered in a chapter 11 case. Section
1141(d)(1) specifies that the confirma-
of reorganization. tion of a plan discharges the debtor
from any debt that arose before the
date of confirmation. After the plan is
confirmed, the debtor is required to
of the entity or entities submitting make plan payments and is bound by
such plan or modification. When com- the provisions of the plan of reorgani-
peting plans are presented and meet zation. The confirmed plan creates new
the requirements for confirmation, contractual rights, replacing or super-
the court must consider the preferences seding pre-bankruptcy contracts.
of the creditors and equity security There are, of course, exceptions to
holders in determining which plan the general rule that an order confirm-
to confirm. ing a plan operates as a discharge.
Any party in interest may file an Confirmation of a plan of reorganiza-
objection to confirmation of a plan. tion will discharge any type of
The Bankruptcy Code requires the debtor—corporation, partnership, or
court, after notice, to hold a hearing on individual—from most types of prepe-
the confirmation of a plan. If no objec- tition debts. It does not, however, dis-
tion to confirmation has been timely charge an individual debtor from any
filed, the Code allows the court to debt made nondischargeable by section
determine that the plan has been pro- 523 of the Bankruptcy Code.
posed in good faith and according to Confirmation does not discharge the

36 • REORGANIZATION UNDER THE BANKRUPTCY CODE

debtor if the plan is a liquidation plan, possession or a trustee to report on the
as opposed to one of reorganization, progress made in implementing a plan
and the debtor is not an individual. after confirmation. A chapter 11 trustee
When the debtor is an individual, con- or debtor in possession has a number of
firmation of a liquidation plan will responsibilities to perform after confir-
effect a discharge unless grounds mation, including consummating the
would exist for denying the debtor a plan, reporting on the status of consum-
discharge if the case were proceeding mation, and applying for a final decree.
under chapter 7 instead of chapter 11.
11 U.S.C. §§ 1141(d)(2), 727(a). REVOCATION OF THE
CONFIRMATION ORDER
POSTCONFIRMATION A revocation of the confirmation order
MODIFICATION OF is an undoing or cancellation of the
THE PLAN confirmation of a plan. A request for
At any time after confirmation and revocation of confirmation, if made at
before “substantial consummation” of all, must be made by a party in interest
a plan, the proponent of a plan may within 180 days of confirmation. The
modify a plan if the modified plan court, after notice and hearing, may
would meet certain Bankruptcy Code revoke a confirmation order “if and
requirements. 11 U.S.C. § 1127(b). only if [the confirmation] order was
This should be distinguished from pre- procured by fraud.” 11 U.S.C. § 1144.
confirmation modification of the plan.
A modified postconfirmation plan does THE FINAL DECREE
not automatically become the plan. A A final decree closing the case must be
modified postconfirmation plan in a entered after the estate has been “fully
chapter 11 case becomes the plan only administered.” Fed. R. Bankr. P. 3022.
“if circumstances warrant such modifi- Local bankruptcy court policies may
cation” and the court, after notice and determine when the final decree should
hearing, confirms the plan as modified be entered and the case closed.
pursuant to chapter 11 of the Code.

POSTCONFIRMATION
ADMINISTRATION
Federal Rule of Bankruptcy Procedure
3020(d) provides that, “[n]otwithstand-
ing the entry of the order of confirma-
tion, the court may issue any other
order necessary to administer the
estate.” This authority would include
the postconfirmation determination of
objections to claims or adversary pro-
ceedings which must be resolved before
a plan can be fully consummated.
Sections 1106(a)(7) and 1107(a) of the
Bankruptcy Code require a debtor in

REORGANIZATION UNDER THE BANKRUPTCY CODE • 37

CHAPTER

12
Chapter 12 of the
Family Farmer
Bankruptcy

BACKGROUND
In tailoring chapter 12 to meet the eco-
Bankruptcy Code was nomic realities of family farming, this
law has eliminated many of the barriers
enacted by Congress in that family farmers had faced when
seeking to reorganize successfully
1986, specifically to meet under either chapter 11 or 13 of the
Bankruptcy Code. For example, chap-
the needs of financially ter 12 is more streamlined, less compli-
cated, and less expensive than chapter
distressed family farmers. 11, which is better suited to the large
corporate reorganization. In addition,
The primary purpose of few family farmers find chapter 13 to
be advantageous, because it was
this legislation was to designed for wage earners who have
smaller debts than those facing family
give family farmers facing farmers. In chapter 12, Congress
sought to combine the features of the
bankruptcy a chance to Bankruptcy Code which can provide a
framework for successful family farm
reorganize their debts reorganizations. At the time of the
enactment of chapter 12, Congress
and keep their farms. could not be sure whether chapter 12
relief for the family farmer would be
required indefinitely. Accordingly, the
law (which first provided that no chap-
ter 12 cases could be filed after
September 30, 1993) currently provides
that no cases may be filed under chap-
ter 12 after July 1, 2000. As of June
30, 2000, legislation is pending in
Congress to extend that deadline.
The Bankruptcy Code provides that
only a family farmer with “regular
annual income” may file a petition for
relief under chapter 12. 11 U.S.C.
§§ 101(18), 109(f). The purpose of this 1. More than one-half of the outstand-
requirement is to ensure that the debtor’s ing stock or equity in the corporation or
annual income is sufficiently stable and partnership must be owned by one fam-
regular to permit the debtor to make ily or by one family and its relatives.
payments under a chapter 12 plan.
Allowance is made under chapter 12, 2. The family or the family and its rela-
however, for situations in which family tives must conduct the farming operation.
farmers may have income that is season-
al in nature. Relief under this chapter is 3. More than 80% of the value of the
voluntary; thus, only the debtor may file corporate or partnership assets must be
a petition under chapter 12. related to the farming operation.
Under the Bankruptcy Code, those
eligible to file as “family farmers” fall 4. The total indebtedness of the corpo-
into two categories: (1) an individual or ration or partnership must not exceed
individual and spouse and (2) a corpo- $1.5 million.
ration or partnership. Those falling into
the first category must meet each of the 5. Not less than 80% of the corpora-
following four criteria as of the date the tion’s or partnership’s total debts which
petition is filed in order to qualify for are fixed in amount must come from the
relief under chapter 12. farming operation owned or operated by
the corporation or partnership.
1. The individual or husband and wife
must be engaged in a farming operation. 6. If the corporation issues stock, the
stock cannot be publicly traded.
2. The total debts (secured and unse-
cured) of that farming operation must
not exceed $1.5 million. HOW CHAPTER 12 WORKS
A chapter 12 case begins with the filing
3. Not less than 80% of the total debts of a petition and several additional
which are fixed in amount must be forms, such as schedules of assets and
related to the farming operation. liabilities, a statement of financial
affairs, a schedule of current income
4. More than 50% of the gross income and expenditures, and a schedule of
of the individual or the husband and executory contracts and unexpired leas-
wife for the receding tax year must have es. Bankruptcy Rule 1007(b)(1). The
come from the farming operation. petition and other forms are filed with
the bankruptcy court serving the area
In order for a corporation or part- where the individual lives or where the
nership to fall within the second cate- corporation or partnership debtor has
gory of debtors eligible to file as “fam- its principal place of business or princi-
ily farmers,” the corporation or part- pal assets. The exact filing require-
nership must meet each of the follow- ments in each jurisdiction are specified
ing criteria as of the date of the filing of in local rules of court which can be
the petition. obtained from the clerk’s office.
(Official Bankruptcy Forms can be pur-

FAMILY FARMER BANKRUPTCY • 39

chased at a legal stationery store. They the trustee’s primary responsibility is to
are not available from the court.) A act as a disbursing agent, receiving pay-
husband and wife may file one joint ments from debtors and making distri-
petition. 11 U.S.C. § 302(a). butions to creditors.
In order to complete the Official The filing of the petition also “auto-
Bankruptcy Forms which make up matically stays” most actions by credi-
the petition and schedules, the debtor tors to collect money or property owed
will need to compile the following to them. 11 U.S.C. § 362. Creditors, by
information: law, generally cannot initiate or contin-
ue any lawsuits, wage garnishments, or
1. A list of all creditors; even telephone calls demanding pay-
ment. Creditors (whose identities and
2. The source, amount, frequency, and mailing addresses are provided by the
reliability of the debtor’s income; debtor) will receive notice of the filing
of the petition from the court.
3. A list of all of the debtor’s property; The debtor must file a plan of
and repayment with the petition or within
90 days afterward, unless the court
4. A detailed list of the debtor’s month- determines that the need for an exten-
ly farming and living expenses, i.e., sion is attributable to circumstances
food, shelter, utilities, taxes, trans- for which the debtor should not be
portation, medicine, feed, fertilizer, etc. held accountable. 11 U.S.C. § 1221.
Plans, which must be approved by the
When a husband and wife intend to court, provide for payments of fixed
file a single, joint petition, they should amounts to the trustee on a regular
gather the above-detailed data for both basis. The trustee then distributes the
spouses. Even when only one spouse funds to creditors according to the
files, however, the income and expenses terms of the plan.
of the non-filing spouse should be There are three types of debt:
included in the petition and schedules, secured, priority, and unsecured.
so that the court can assess accurately Secured debts are those for which the
the debtor’s financial responsibilities. creditor has the right to pursue specific
Currently, the courts are required to pledged property upon default. Priority
charge a $200 filing fee. This fee should debts are those granted special status
be paid in full upon filing or, with the by the bankruptcy law, such as most
court’s permission, the fee for an indi- taxes and the costs of the bankruptcy
vidual debtor may be paid in up to proceeding. Unsecured debts generally
four installments. Bankruptcy Rule are characterized as those debts for
1006(b)(1). If a joint petition is filed, which credit was extended based solely
only one $200 fee is charged. on the creditor’s assessment of the
Upon the filing of the petition, an debtor’s future ability to pay.
impartial trustee is appointed by the The debtor’s plan usually lasts three
court or the United States trustee to to five years. It must provide for pay-
administer the case. 11 U.S.C. § 1202; ment in full to all priority creditors.
28 U.S.C. § 586(b). As in chapter 13, 11 U.S.C. § 1222(a)(2). The plan need

40 • FAMILY FARMER BANKRUPTCY

not provide that unsecured creditors
be paid in full, as long as the debtor
pays under the plan all projected “dis- The debtor must file
posable income” over the three to five
years that the plan is in effect and as a plan of repayment
long as the plan provides that unse-
cured creditors are to receive at least with the petition
as much as they would receive if the
debtor’s nonexempt assets were liqui- or within 90 days
dated under chapter 7. 11 U.S.C.
§ 1225. “Disposable income” is afterward, unless
defined as income which is not rea-
sonably necessary for the mainte- the court determines
nance or support of the debtor or
his/her dependents or for the payment that the need for
of expenditures necessary for the con-
tinuation, preservation, and operation an extension is
of the debtor’s business. 11 U.S.C.
§ 1225(b)(2)(A) and (B). attributable to
Secured creditors must be paid at
least as much as the value of the col- circumstances for
lateral pledged for the debt. One of the
features of Chapter 12 is that, in cer- which the debtor
tain circumstances, payments to
secured creditors can continue longer should not be held
than the three-to-five-year period the
plan provides for payment to unse- accountable.
cured and priority creditors.
Approximately 20 to 35 days after
the petition is filed, a “meeting of cred-
itors” is held. The debtor must attend ing or shortly after the creditors’ meet-
this meeting, at which creditors may ing. Generally, problems may be avoid-
appear and ask questions regarding the ed if the petition and plan are complete
debtor’s financial affairs and the pro- and accurate and the trustee has been
posed terms of the plan. 11 U.S.C. consulted prior to the meeting.
§ 343; Bankruptcy Rule 4002. (If a hus- Within 45 days after the filing of the
band and wife have filed a joint peti- plan, the presiding bankruptcy judge
tion, both must attend the creditors’ must determine at a “confirmation
meeting.) The trustee will also attend hearing” whether the plan is feasible
the meeting and question the debtor. In and meets the standards for confir-
order to preserve their independent mation under the Bankruptcy Code.
judgment, bankruptcy judges are pro- 11 U.S.C. §§ 1224 and 1225. Creditors
hibited from attending meetings of cred- may appear at the hearing and object
itors. 11 U.S.C. § 341(c). Any problems to confirmation. While a variety of
with the plan are typically resolved dur- objections may be made, the typical

FAMILY FARMER BANKRUPTCY • 41

 arguments are that payments offered plan is not confirmed, the funds paid
under the plan are less than creditors to the trustee are returned to the
would receive if the debtor’s assets debtor after deducting the trustee’s
were liquidated or that the plan does percentage fee and any unpaid claim
not commit all of the debtor’s dispos- allowed for administrative expenses.
able income for the three-to-five-year 11 U.S.C. § 1226(a).
period of the plan. On occasion, changed circumstances
will affect a debtor’s ability to make
payments or a debtor may inadvertent-
ly have failed to list all creditors. In
such instances, the plan may be modi-
Upon successful fied either before or after confirmation.
11 U.S.C. §§ 1223 and 1229.
completion of all
MAKING THE PLAN WORK
payments under a Once the court confirms the plan, it is
incumbent upon the debtor to make
chapter 12 plan, the the plan succeed. The debtor must
make regular payments to the trustee.
debtor will receive a Further, while confirmation of the plan
entitles the debtor to retain property as
“discharge” which long as payments are made, 11 U.S.C.
§ 1227(b), the debtor should not incur
extinguishes the any significant new credit obligations
without consulting the trustee, because
debtor’s obligation they may impact upon the successful
execution of the plan. In any event,
to pay any unsecured failure to make the plan payments
may result in dismissal of the case.
debts that were 11 U.S.C. § 1208(c). In addition, the
court may dismiss the case or convert
included in the plan, the case to a liquidation case under
chapter 7 of the Bankruptcy Code
even though they upon a showing that the debtor has
committed fraud in connection with
may not have been the case. 11 U.S.C. § 1208(d).

paid in full. THE CHAPTER 12

DISCHARGE
As is the case under chapter 13, upon
successful completion of all payments
If the plan is confirmed by the bank- under a chapter 12 plan, the debtor will
ruptcy judge, the trustee commences receive a “discharge” which extinguish-
distribution of the funds the trustee es the debtor’s obligation to pay any
has received from the debtor. If the unsecured debts that were included in

42 • FAMILY FARMER BANKRUPTCY

the plan, even though they may not ments under a plan of reorganization.
have been paid in full. 11 U.S.C. If the court finds that such circum-
§ 1228. After the discharge has been stances exist and that unsecured credi-
granted, those creditors whose claims tors already have received at least
were provided for in full or in part what they would have received if the
under the plan no longer may initiate debtor’s estate had been liquidated
or continue any legal or other action under chapter 7 of the Bankruptcy
against the debtor to collect the dis- Code, the bankruptcy court may grant
charged obligations. the debtor a discharge of all unsecured
Certain categories of debts are not debts provided for in the plan or disal-
discharged in chapter 12 proceedings. lowed by the court, with the exception
11 U.S.C. § 1228(a). Those categories of those types of debts which are
include debts for alimony and child excepted from discharge. Injury or ill-
support; money obtained through fil- ness that precludes employment suffi-
ing false financial statements; debts for cient to fund even a modified plan
willful and malicious injury to person may serve as the basis for a discharge
or property; debts for death or person- under section 1228(c). A discharge
al injury caused by the debtor’s opera- granted under section 1228(c) is often
tion of a motor vehicle while the referred to as a “hardship discharge.”
debtor was intoxicated; and debts
from fraud or defalcation while acting
in a fiduciary capacity, embezzlement
or larceny. In fact, the discharge is
more limited in chapter 12 than it is in
a chapter 13 case. The bankruptcy law
regarding the scope of a chapter 12
discharge is complex, however, and
debtors should consult competent legal
counsel in this regard prior to filing.
Those debts which will not be dis-
charged should be paid in full under a
plan. With respect to secured obliga-
tions, those debts may be paid beyond
the end of the plan payment period
and, accordingly, are not discharged.

CHAPTER 12
HARDSHIP DISCHARGE
If payments under a plan are not com-
pleted due to circumstances for which
the family farmer “should not justly
be held accountable,” 11 U.S.C.
§ 1228(b)(1), and other statutory cri-
teria have been met, a family farmer
may be excused from completing pay-

FAMILY FARMER BANKRUPTCY • 43

CHAPTER

9
In the more than 60 years
Municipality
Bankruptcy

HISTORY OF CHAPTER 9
The first municipal bankruptcy legisla-
since Congress established tion was enacted in 1934 during the
Great Depression. Pub. L. No. 251, 48
a federal mechanism for Stat. 798 (1934). Although Congress
took care to draft the legislation so as
the resolution of municipal not to interfere with the sovereign pow-
ers of the states as guaranteed by the
debts, there have been Tenth Amendment to the Constitution,
the Supreme Court held the 1934
fewer than 500 municipal Act unconstitutional as an improper
interference with the sovereignty of
bankruptcy petitions filed. the states. Ashton v. Cameron County
Water Improvement District No. 1,
Although chapter 9 cases 298 U.S. 513 (1936). Congress enacted
a revised Municipal Bankruptcy Act in
are rare, a filing by a large 1937, Pub. L. No. 302, 50 Stat. 653
(1937), which was upheld by the
municipality can—like the Supreme Court. United States v.
Bekins, 304 U.S. 27 (1938). The law
1994 filing by Orange has been amended several times since
1937, most recently in 1994 (amending
County, California—involve section 109(c)) as part of the
Bankruptcy Reform Act of 1994, Pub.
many millions of dollars in L. No. 103–394, 108 Stat. 4106 (codi-
fied as amended at 11 U.S.C. §§ 901 to
municipal debt. 946) (1994). In the more than 60 years
since Congress established a federal
mechanism for the resolution of munic-
ipal debts, there have been fewer than
500 municipal bankruptcy petitions
filed. Although chapter 9 cases are rare,
a filing by a large municipality can—
like the 1994 filing by Orange County,
California—involve many millions of
dollars in municipal debt.
PURPOSE OF MUNICIPAL MEDIA INTEREST
BANKRUPTCY The news media frequently is more
The purpose of chapter 9 is to provide interested in municipal bankruptcy
a financially-distressed municipality cases than in cases filed by individuals
protection from its creditors while it or small businesses. As a consequence,
develops and negotiates a plan for some courts have a written policy for
adjusting its debts. Reorganization of court personnel regarding the infor-
the debts of a municipality is typically mation that may or may not be
accomplished either by extending debt released to the media in a case filed
maturities, reducing the amount of under chapter 9. Some courts also des-
principal or interest, or refinancing the ignate a public information officer to
debt by obtaining a new loan. act as the contact person for all media
Although similar to other chapters in inquiries concerning the municipal
some respects, chapter 9 is significantly bankruptcy case.
different in that there is no provision in
the law for liquidation of the assets of ELIGIBILITY
the municipality and distribution of the Only a “municipality” can file for relief
proceeds to creditors. Such a liquida- under chapter 9. The term “municipali-
tion or dissolution would undoubtedly ty” is defined in the Code to mean
violate the Tenth Amendment to the “political subdivision or public agency
Constitution and the reservation to the or instrumentality of a State.” 11 U.S.C.
states of sovereignty over their internal § 101(40). The definition is broad
affairs. Indeed, due to the severe limita- enough to include cities, counties, town-
tions placed upon the power of the ships, school districts, and public
bankruptcy court in chapter 9 cases improvement districts. It also includes
(required by the Tenth Amendment and revenue-producing bodies that provide
the Supreme Court’s decisions in cases services which are paid for by users
upholding municipal bankruptcy legis- rather than by general taxes, such as
lation), the bankruptcy court generally bridge authorities, highway authorities,
is not as active in managing a munici- and gas authorities.
pal bankruptcy case as it is in corporate There are three additional eligibility
reorganizations under chapter 11. The requirements for chapter 9:
functions of the bankruptcy court in
chapter 9 cases are generally limited to 1. the entity must be specifically autho-
approval of the petition (if the debtor is rized to be a debtor under such chapter
eligible), confirmation of a plan of debt by State law or by a governmental offi-
adjustment, and ensuring implementa- cer or organization empowered by
tion of the plan. As a practical matter, State law to authorize such entity to be
however, the municipality may consent a debtor under such chapter,
to have the court exercise jurisdiction
in many of the traditional areas of 2. the municipality must be insolvent as
court oversight in bankruptcy, in order defined in 11 U.S.C. § 101(32)(C), and
to obtain the protection of court orders
and eliminate the need for multiple 3. the municipality must desire to effect
forums to decide issues. a plan to adjust such debts and either

MUNICIPALITY BANKRUPTCY • 45
 • has obtained the agreement of cred- ASSIGNMENT OF CASE TO
itors holding at least a majority in A BANKRUPTCY JUDGE
amount of the claims of each class that One significant difference between
the debtor intends to impair under a chapter 9 cases and cases filed under
plan in a case under chapter 9; other chapters is that the clerk of
• has negotiated in good faith with court does not automatically assign
creditors and has failed to obtain the the case to a particular judge. “The
agreement of creditors holding at least chief judge of the court of appeals for
a majority in amount of the claims of the circuit embracing the district in
each class that the debtor intends to which the case is commenced [desig-
impair under a plan; nates] the bankruptcy judge to con-
• is unable to negotiate with credi- duct the case.” 11 U.S.C. § 921(b).
tors because such negotiation is This provision was designed to remove
impracticable; or politics from the issue of which judge
• reasonably believes that a creditor will preside over the chapter 9 case of
may attempt to obtain a preference. a major municipality and to ensure
11 U.S.C. § 109(c). that a municipal case will be handled
by a judge who has the time and capa-
COMMENCEMENT bility of doing so. S. Rep. No. 458,
OF THE CASE 94th Cong., 1st Sess. 15 (1975) (leg-
Municipalities must voluntarily seek islative history of Bankruptcy Act—
protection under the Bankruptcy Code. Debts of Municipalities, Pub. L. No.
11 U.S.C. §§ 303, 901(a). They may 94–260, 90 Stat. 315 (1976)). See also
file a petition only under chapter 9. A S. Rep. No. 989, 95th Cong., 2d Sess.
case under chapter 9 concerning an 110 (1978).
unincorporated tax or special assess-
ment district that does not have such NOTICE OF
district’s own officials is commenced by CASE/OBJECTIONS/
the filing of a voluntary “petition under ORDER FOR RELIEF
this chapter by such district’s governing The Bankruptcy Code requires that
authority or the board or body having notice be given of the commencement
authority to levy taxes or assessments of the case and the order for relief.
to meet the obligations of such dis- 11 U.S.C. § 923. The Bankruptcy Rules
trict.” 11 U.S.C. § 921(a). provide that the clerk, or such other
A municipal debtor is required to file person as the court may direct, is to give
a list of creditors. 11 U.S.C. § 924. notice. Fed. R. Bankr. P. 2002(f). Such
Normally, the list of creditors is filed notice must also be published “at least
with the petition. However, in some sit- once a week for three successive weeks
uations, the debtor may not have ade- in at least one newspaper of general cir-
quate time to prepare a list of creditors culation published within the district in
in the form and with the detail required which the case is commenced, and in
by the Bankruptcy Rules. Thus, the such other newspaper having a general
Bankruptcy Rules permit the court to circulation among bond dealers and
fix a time within which the list must be bondholders as the court designates.”
filed. Fed. R. Bankr. P. 1007. 11 U.S.C. § 923. The court typically

46 • MUNICIPALITY BANKRUPTCY
enters an order designating who is to prohibits a creditor from bringing an
give and receive notice by mail and action against an inhabitant of the
identifying the newspapers in which the debtor to enforce a lien on or arising
additional notice is to be published. out of taxes or assessments owed to
Fed. R. Bankr. P. 9008. the debtor. Section 922(d) of title 11
The Bankruptcy Code permits objec- limits the applicability of the stay.
tions to the petition to be filed. Pursuant to that section, a chapter 9
11 U.S.C. § 921(c). Typically, objec- petition does not operate to stay appli-
tions concern issues like whether nego- cation of pledged special revenues to
tiations have been conducted in good payment of indebtedness secured by
faith, whether the state has authorized such revenues. Thus, an indenture
the municipality to file, and whether trustee or other paying agent may
the petition was filed in good faith. If apply pledged funds to payments com-
an objection to the petition is filed, the ing due or distribute the pledged funds
court must hold a hearing on the objec- to bondholders without violating the
tion. Id. The court may dismiss a peti- automatic stay.
tion if it determines that the debtor did
not file the petition in good faith or PROOFS OF CLAIM
that the petition does not meet the In a chapter 9 case, the court fixes the
requirements of title 11. Id. time within which proofs of claim or
If the petition is not dismissed upon interest may be filed. Fed. R. Bankr. P.
an objection, the Bankruptcy Code 3003(c)(3). Many creditors may not be
requires the court to order relief, allow- required to file a proof of claim in a
ing the case to proceed under chapter 9. chapter 9 case. For example, a proof of
11 U.S.C. § 921(d). claim is deemed filed if it appears on
the list of creditors filed by the debtor,
AUTOMATIC STAY unless the debt is listed as disputed,
The automatic stay of section 362 of contingent, or unliquidated. 11 U.S.C.
the Bankruptcy Code is applicable in § 925. Thus, a creditor must file a
chapter 9 cases. 11 U.S.C. §§ 362(a), proof of claim, if the creditor’s claim
901(a). The stay operates to stop all appears on the list of creditors as dis-
collection actions against the debtor puted, contingent, or unliquidated.
and its property upon the filing of the
petition. There is another provision of COURT’S LIMITED POWER
the Code, however, which expands the Two of chapter 9’s provisions are
stay to entities other than the debtor. designed to recognize the court’s limited
The additional automatic stay provi- power over operations of the debtor:
sions under section 922(a) prohibit sections 903 and 904. Section 904 of the
actions against officers and inhabi- Code limits the power of the bankrupt-
tants of the debtor if the action seeks cy court to “interfere with (1) any of the
to enforce a claim against the debtor. political or governmental powers of the
Thus, the stay prohibits a creditor debtor; (2) any of the property or rev-
from bringing a mandamus action enues of the debtor; or (3) the debtor’s
against an officer of a municipality on use or enjoyment of any income-produc-
account of a prepetition debt. It also ing property,” unless the debtor consents

MUNICIPALITY BANKRUPTCY • 47
 or the plan so provides. The provision Moreover, the chapter 9 debtor may
makes it clear that the debtor’s day-to- employ professionals without court
day activities are not subject to court approval, and the only court review of
approval and that the debtor may bor- fees is in the context of plan confirma-
row money without court authority. In tion, when the court determines the rea-
addition, the court cannot appoint a sonableness of the fees. The restrictions
trustee (except for limited purposes imposed by section 904 are necessary in
specified in section 926(a)) and cannot order to ensure the constitutionality of
chapter 9 and to avoid the possibility
that the court might substitute its con-
trol over the political or governmental
Although similar affairs or property of the debtor for that
of the state and the elected officials of
to other chapters the municipality.
Similarly, section 903 of the Code
in some respects, states that “chapter [9] does not limit
or impair the power of a State to con-
chapter 9 is trol, by legislation or otherwise, a
municipality of or in such State in the
significantly different exercise of the political or governmen-
tal powers of the municipality, includ-
in that there is no ing expenditures for such exercise,”
with two exceptions—a state law pre-
provision in the scribing a method of composition of
municipal debt does not bind any non-
law for liquidation consenting creditor, nor does any judg-
ment entered under such state law bind
of the assets of the a nonconsenting creditor.

municipality and ROLE OF THE UNITED

STATES TRUSTEE/
distribution of the BANKRUPTCY
ADMINISTRATOR
proceeds to creditors. The role of the United States trustee in
chapter 9 cases is typically more limit-
ed than in chapter 11 cases. Although
the United States trustee appoints a
convert the case to a liquidation pro- creditors’ committee, the United States
ceeding. The court also cannot interfere trustee does not examine the debtor at
with the operations of the debtor or a meeting of creditors (there is no meet-
with the debtor’s use of its property and ing of creditors), does not have the
revenues. This is due, at least in part, to authority to move for appointment of a
the fact that in a chapter 9 case there is trustee or examiner or for conversion
no property of the estate and thus no of the case, and does not supervise the
estate to administer. 11 U.S.C. § 902(1). administration of the case. Nor does

48 • MUNICIPALITY BANKRUPTCY
the United States trustee monitor the shall, intervene in a chapter 9 case.” Fed.
financial operations of the debtor or R. Bankr. P. 2018(c). In addition,
review the fees of professionals retained “[r]epresentatives of the state in which
in the case. Bankruptcy Administrators the debtor is located may intervene in a
serve a similar limited function in chap- chapter 9 case. Id. In addition, section
ter 9 cases filed in the six judicial dis- 1109 of the Bankruptcy Code permits
tricts in the states of Alabama and the Securities and Exchange Commission
North Carolina. to appear and be heard on any issue and
gives parties in interest the right to
ROLE OF CREDITORS appear and be heard on any issue in a
The creditors’ role is more limited in case. 11 U.S.C. § 901(a). Among those
chapter 9 than in other cases. There is that may be interested in being heard in
no first meeting of creditors and credi- a chapter 9 case are municipal employ-
tors may not propose a plan of adjust- ees, local residents, non-resident owners
ment. If certain requirements are met, of real property, special tax payers, secu-
the debtor’s plan of adjustment is bind- rities firms, and local banks.
ing on dissenting creditors. The chapter
9 debtor has more freedom to operate POWERS OF THE DEBTOR
without court-imposed restrictions. In Due to statutory limitations placed
each chapter 9 case, however, there is a upon the power of the court in a
creditors’ committee that has powers municipal debt adjustment proceeding,
and duties that are very similar to those the court is far less involved in the con-
of a committee in a chapter 11 case. duct of a municipal bankruptcy case
These powers and duties include select- (and in the operation of the municipal
ing and authorizing the employment of entity) while the debtor’s financial
one or more attorneys, accountants, or affairs are undergoing reorganization.
other agents to represent the committee, The debtor has broad powers to use its
consulting with the debtor concerning property, raise taxes, and make expen-
administration of the case, investigating ditures as it sees fit. The debtor is also
the acts, conduct, assets, liabilities, and permitted to adjust burdensome non-
financial condition of the debtor, partic- debt contractual relationships under
ipating in the formulation of a plan, and the power to reject executory contracts
performing such other services as are and unexpired leases, subject to court
in the interest of those represented. approval. Municipalities may also
11 U.S.C. §§ 901(a), 1103. reject collective bargaining agreements
and retiree benefit plans without going
INTERVENTION/RIGHT OF through the usual procedures required
OTHERS TO BE HEARD in chapter 11 cases. The municipality
When cities or counties file for relief also has the authority to borrow money
under chapter 9, there may be a great during a chapter 9 case as an adminis-
deal of interest in the case from entities trative expense. 11 U.S.C. §§ 364,
wanting to appear and be heard. The 901(a). This ability is important to the
Bankruptcy Rules provide that “[t]he survival of a municipality that has
Secretary of the Treasury of the United exhausted all other resources. A chap-
States may, or if requested by the court ter 9 municipality has the same power

MUNICIPALITY BANKRUPTCY • 49
to obtain credit as it does outside of negotiation and possible restructuring
bankruptcy. The court does not have under the plan of adjustment.
supervisory authority over the amount Special revenue bonds, by contrast,
of debt the municipality incurs in its will continue to be secured and serviced
operation. The municipality also has during the pendency of the chapter 9
the same avoiding powers as other case through continuing application and
debtors, may employ professionals payment of ongoing special revenues.
without court approval, and fees are 11 U.S.C. § 928. Holders of special rev-
reviewed only within the context of enue bonds can expect to receive pay-
plan confirmation. ment on such bonds during the chapter 9
case if special revenues are available. The
DISMISSAL application of pledged special revenues
As noted above, if an objection is filed, to indebtedness secured by such revenues
the court may dismiss the petition after is not stayed as long as the pledge is
notice and a hearing if the debtor did consistent with section 928 [§ 922(d)
not file the petition in good faith or if erroneously refers to § 927 rather than
the petition does not meet the require- § 928] of the Code, which insures that a
ments of chapter 9. 11 U.S.C. § 921(c). lien of special revenues is subordinate to
A chapter 9 case may also be dismissed, the operating expenses of the project or
after notice and a hearing, for cause, system from which the revenues are
including lack of prosecution, unrea- derived. 11 U.S.C. § 922(d).
sonable delay by the debtor that is prej- Bondholders generally do not have to
udicial to creditors, failure to propose a worry about the threat of preference lia-
plan within the time fixed by the court, bility with respect to any prepetition
nonacceptance of a plan within the time payments on account of bonds or notes,
fixed by the court, denial of plan confir- whether special revenue or general
mation and denial of additional time for obligations. Any transfer of the munici-
filing another plan, material default by pal debtor’s property to a noteholder or
the debtor under a confirmed plan, or bondholder on account of a note or
termination of a confirmed plan by rea- bond cannot be avoided as a preference,
son of the occurrence of a condition i.e., as an unauthorized payment to a
specified in the plan. 11 U.S.C. § 930. creditor made while the debtor was
insolvent. 11 U.S.C. § 926(b).
TREATMENT OF
BONDHOLDERS AND PLAN FOR ADJUSTMENT
OTHER LENDERS OF DEBTS
Different types of bonds receive differ- The Bankruptcy Code provides that the
ent treatment in municipal bankruptcy debtor shall file a plan. 11 U.S.C.
cases. General obligation bonds are § 941. The plan must be filed with the
treated as general debt in the chapter 9 petition or at such later time as the
case. The municipality is not required court fixes. There is no provision in
to make payments of either principal or chapter 9 allowing creditors or other
interest on account of such bonds dur- parties in interest to file a plan. This
ing the case. The obligations created by limitation is required by the Supreme
general obligation bonds are subject to Court’s pronouncements in Ashton,

50 • MUNICIPALITY BANKRUPTCY
298 U.S. at 513, and Bekins, 304 U.S. provides that on the effective date of the
at 27, which interpreted the Tenth plan each holder of a claim of a kind
Amendment as requiring that a munic- specified in section 507(a)(1) will receive
ipality be left in control of its govern- on account of such claim cash equal to
mental affairs during a chapter 9 case. the allowed amount of such claim;
Neither creditors nor the court may
control the affairs of a municipality 6. any regulatory or electoral approval
indirectly through the mechanism of necessary under applicable nonbank-
proposing a plan of adjustment of the ruptcy law in order to carry out any
municipality’s debts that would in provision of the plan has been ob-
effect determine the municipality’s tained, or such provision is expressly
future tax and spending decisions. conditioned on such approval; and

CONFIRMATION 7. the plan is in the best interests of

STANDARDS creditors and is feasible.
The standards for plan confirmation in
chapter 9 cases are a combination of the 11 U.S.C. § 943(b).
statutory requirements of 11 U.S.C.
§ 943(b) and those portions of 11 U.S.C. Section 943(b)(1) requires as a condi-
§ 1129 (the chapter 11 confirmation tion to confirmation that the plan com-
standards) that are made applicable by ply with the provisions of the
11 U.S.C. § 901(a). Section 943(b) lists Bankruptcy Code made applicable by
seven general conditions to confirmation sections 103(e) and 901(a) of the Code.
of a plan. The court must confirm a plan The most important of these for purpos-
if the following conditions are met: es of confirming a plan are those provi-
sions of section 1129 of the Code
1. the plan complies with the provisions (1129(a)(2), (a)(3), (a)(6), (a)(8), (a)(10))
of title 11 made applicable by sections that are made applicable by section
103(e) and 901; 901(a). Section 1129(a)(8) requires as a
condition to confirmation that the plan
2. the plan complies with the provisions has been accepted by each class of
of chapter 9; claims or interests that is impaired under
the plan. Therefore, if the plan proposes
3. all amounts to be paid by the debtor treatment for a class of creditors such
or by any person for services or expens- that the class is impaired (the creditor’s
es in the case or incident to the plan have legal, equitable, or contractual rights are
been fully disclosed and are reasonable; altered), then that class’s acceptance is
required. If the class is not impaired,
4. the debtor is not prohibited by law then acceptance by that class is not
from taking any action necessary to required as a condition to confirmation.
carry out the plan; Under section 1129(a)(10), the court
may confirm the plan only if, should any
5. except to the extent that the holder of class of claims be impaired under the
a particular claim has agreed to a differ- plan, at least one impaired class has
ent treatment of such claim, the plan accepted the plan. Even if no impaired

MUNICIPALITY BANKRUPTCY • 51
classes of creditors consent to the plan, tion, including creditors whose claims
plan confirmation is still possible under are affected by the plan, an organization
the “cram down” provisions of section of employees of the debtor, and other
1129(b). Under “cram down,” if all tax payers, as well as the Securities
other requirements are met except the and Exchange Commission. 11 U.S.C.
section 1129(a)(8) requirement that all §§ 1109(a), 1128(b), 901(a).
classes either be unimpaired or have
accepted the plan, then the plan is con- DISCHARGE
firmable if it does not discriminate A municipal debtor receives a discharge
unfairly and is fair and equitable. in a chapter 9 case after (1) confirma-
The requirement that the plan be in tion of the plan, (2) deposit by the
the “best interests of creditors” means debtor of any consideration to be dis-
something different in chapter 9 than tributed under the plan with the dis-
under chapter 11. Under chapter 11, a bursing agent appointed by the court,
plan is said to be in the “best interests and (3) a determination by the court
of creditors” if creditors would receive that securities deposited with the dis-
as much under the plan as they would bursing agent will constitute valid legal
if the debtor were liquidated. 11 U.S.C. obligations of the debtor and that
§ 1129(a)(7)(A)(ii). Obviously, a differ- any provision made to pay or secure
ent interpretation is needed in chapter 9 payment of such obligations is valid.
cases because a municipality’s assets 11 U.S.C. § 944(b). Thus, the discharge
cannot be liquidated to pay creditors. is conditioned not only upon confirma-
In the chapter 9 context, the “best tion, but also upon deposit of the con-
interests of creditors” test has generally sideration to be distributed under the
been interpreted to mean that the plan plan and a court determination of the
must be better than other alternatives validity of securities to be issued.
available to the creditors. See 4 Collier There are two exceptions to the dis-
on Bankruptcy ¶ 943.03[7] (15th ed. charge in chapter 9 cases. The first is
1994). Generally speaking, the alterna- for any debt excepted from discharge
tive to chapter 9 is dismissal of the case, by the plan or order confirming the
permitting every creditor to fend for plan. The second exception is for a debt
itself. An interpretation of the best owed to an entity that, before confir-
interests of creditors test to require that mation of the plan, had neither notice
the municipality devote all resources nor actual knowledge of the case.
available to the repayment of creditors 11 U.S.C. § 944(c).
would appear to exceed the standard. At any time within 180 days after
The courts generally apply the test to entry of the confirmation order, the
require a reasonable effort by the court may, after notice and a hearing,
municipal debtor that is a better alter- revoke the order of confirmation if the
native for its creditors than dismissal of order was procured by fraud. 11 U.S.C.
the case. Id. §§ 901(a) and 1144.
A special tax payer affected by the The court may retain jurisdiction over
plan may object to confirmation of the the case for such period of time as is nec-
plan. 11 U.S.C. § 943(a). Other parties essary for the successful implementation
in interest may also object to confirma- of the plan. 11 U.S.C. § 945(a).

52 • MUNICIPALITY BANKRUPTCY
Securities
Investor S I PA
Protection Act

OVERVIEW Since being established by

Typically, when a brokerage firm fails,
the SIPC will arrange to have the failed Congress in 1970, the
brokerage’s accounts transferred to a
different securities brokerage firm. If Securities Investor Protection
the SIPC is unable to arrange the
accounts’ transfer, the failed firm is liq- Corporation has protected
uidated. In that case, the SIPC will send
investors either certificates for the stock investors who leave stocks,
that was lost or a check for the market
value of the shares. bonds, other securities and
Although the Bankruptcy Code pro-
vides for a stockbroker liquidation pro- cash with brokerage firms by
ceeding, 11 U.S.C. § 741 et seq., it is
far more likely that a failing brokerage ensuring that every customer
will find itself involved in a SIPA pro-
ceeding rather than a Bankruptcy Code gets back what he or she left
liquidation case. Brokerage firms may
be liquidated under the Bankruptcy with the firm—up to $500,000
Code, however, if SIPC does not file an
application for a protective decree with per customer, including no
the district court or if the district court
finds that customers of the brokerage more than $100,000 cash. The
firm are not in need of protection under
SIPA. 15 U.S.C. §§ 78eee. sole function of SIPC is to
HISTORY return to investors securities
Prior to 1938, little protection existed
for customers of a bankrupt stockbroker and cash left with failed bro-
unless they could trace cash and securi-
ties held by failed stockbrokers. In 1938 kerages. It does not protect
Congress enacted section 60e of the
Bankruptcy Act and created a single and investors against losses in the
separate fund concept which was intend-
ed to minimize losses to customers by securities markets.
giving them priority over claims of gen-
eral creditors. 1898 Bankruptcy Act § Protection Corporation (hereinafter
60(e)(2) (repealed). Because the fund referred to as SIPC). SIPA was designed
was normally inadequate, however, cus- to create a new form of liquidation
tomer losses continued. proceeding. It is applicable only to
Following a period of great expan- member firms and was designed to
sion in the securities industry during accomplish the completion of open
the 1960’s, a serious business contrac- transactions and the speedy return of
tion hit the industry in 1969–1970. most customer property. Id.
This situation led to voluntary liquida-
tions, mergers, receiverships, and bank- SIPA
ruptcies of a substantial number of bro- SIPA is codified as Title 15, United
kerage houses. Annotation, Validity, States Code, Sections 78aaa–111. SIPA
Construction, and Application of created SIPC, a nonprofit, private mem-
Securities Investor Protection Act of bership corporation to which most reg-
1970 (15 U.S.C.S. §§ 78aaa et seq.), 23 istered brokers and dealers are required
A.L.R. Fed. 157, 179 (1975). Cus- to belong. 15 U.S.C. § 78ccc. The SIPC
tomers of these firms found the cash fund, which constitutes an insurance
and securities which they had on program, is authorized under 15 U.S.C.
deposit dissipated or tied up in lengthy § 78ddd(a) and assessments against
bankruptcy proceedings. Along with members are authorized by 15 U.S.C.
the concern over mounting customer §§ 78ddd(c) and (d). The fund is
losses and the subsequent erosion of designed to protect the customers of
investor confidence, the Congress was brokers or dealers subject to SIPA from
also concerned with a possible “domi- loss in case of financial failure of the
no effect” involving otherwise solvent member. The fund is supported by
brokers that had substantial open assessments upon its members. If the
transactions with firms that failed. In fund should become inadequate, SIPA
reaction to this growing concern, the authorizes borrowing against the U.S.
Congress enacted the Securities Treasury. An analogy could be made to
Investor Protection Act of 1970 (here- the role of the Federal Deposit Insurance
inafter referred to as SIPA). The goal Corporation in the banking industry.
was to arrest this process, restore
investor confidence in the capital mar- BANKRUPTCY
kets, and upgrade the financial respon- LIQUIDATION VERSUS
sibility requirements for registered bro- SIPA LIQUIDATION IN
kers and dealers. Securities Investor BANKRUPTCY COURT
Protection Corp. v. Barbour, 421 U.S. The essential difference between a
412, 414 (1975). SIPA was designed to liquidation under the Bankruptcy Code
apportion responsibility for carrying (11 U.S.C. §§ 741–752) and one under
out the various goals of the legislation SIPA is that under the Code the trustee
to several groups. Among them are the is charged with converting securities to
Securities and Exchange Commission cash as quickly as possible and, with
(hereinafter referred to as SEC), various the exception of the delivery of cus-
securities industry self-regulatory orga- tomer name securities, making cash dis-
nizations, and the Securities Investor tributions to customers of the debtor in

54 • SECURITIES INVESTOR PROTECTION ACT

satisfaction of their claims. A SIPC the debtor-defendant. In the event that
trustee, on the other hand, is required to the SIPC refuses to act under the SIPA,
distribute securities to customers to the the SEC may apply to the United States
greatest extent practicable in satisfac- District Court for the District of
tion of their claims against the debtor. Columbia to require the SIPC to dis-
There is a fundamental difference in charge its obligations under SIPA.
orientation between the two proceed- 15 U.S.C. § 78ggg(b). By contrast, cus-
ings. There is a statutory grant of tomers of failing broker-dealers do not
authority to a SIPC trustee to purchase have an implied right of action under
securities to satisfy customer net equity SIPA to compel the SIPC to exercise its
claims to specified securities. 15 U.S.C. statutory authority for their benefit.
§ 78fff–2(d). The trustee is required Barbour at 425. Upon the filing of an
to return customer name securities application, the district court has exclu-
to customers of the debtor (15 U.S.C. sive jurisdiction of the debtor-defen-
§ 78fff–2)(c)(2)), distribute the fund of dant and its property.
“customer property” ratably to cus- The institution of a case under SIPA
tomers (15 U.S.C. § 78fff–2(b)), and brings a pending bankruptcy liquidation
pay, with money from the SIPC fund, to a halt. Irrespective of the automatic
remaining customer net equity claims, stay, SIPC may file an application for a
to the extent provided by the Act protective decree under SIPA. 11 U.S.C.
(15 U.S.C. §§ 78fff–2(b) and 3(a)). A § 742; 15 U.S.C. § 78aaa et seq. The fil-
trustee operating under the Code lacks ing stays all proceedings in the bank-
similar resources. The Code seeks to ruptcy case until the SIPC action is com-
protect the filing date value of a cus- pleted. Id. Pending issuance of a protec-
tomer’s securities account by liquidat- tive decree, the district court:
ing all non-customer name securities.
SIPA seeks to preserve an investor’s [i.] shall stay any pending bankruptcy,
portfolio as it stood on the filing date. mortgage foreclosure, equity receiver-
Under SIPA, the customer will receive ship, or other proceeding to reorganize,
securities whenever possible. conserve, or liquidate the debtor or its
property and any other suit against any
ROLE OF THE receiver, conservator, or trustee of the
DISTRICT COURT debtor or its property, and shall contin-
15 U.S.C. § 78eee(a)(3)(A) provides ue such stay upon appointment of a
that SIPC may file an application for a trustee …
protective decree with the United States
district court if SIPC determines that [ii.] may stay any proceeding to enforce
any member has failed or is in danger a lien against property of the debtor or
of failing to meet obligations to any other suit against the debtor,
customers and meets one of the four including a suit by stockholders of the
conditions specified in 15 U.S.C. debtor which interferes with prosecu-
§ 78eee(b)(1). This application will be tion by the trustee of claims against for-
filed as a civil case in which SIPC or the mer directors, officers, or employees of
SEC or both are named as plaintiff, and the debtor, and may continue such stay
the member securities firm is named as upon appointment of a trustee ...

SECURITIES INVESTOR PROTECTION ACT • 55

[iii.] may stay enforcement of, and charged. The reason for using an adver-
upon appointment of a trustee ... [if a sary proceeding number is historical.
protective decree is issued] ... may con- While these SIPA proceedings are not
tinue the stay for such period of time as bankruptcy cases, by law certain proce-
may be appropriate, but shall not abro- dures prescribed in chapters 1, 3, and 5,
gate,[sic] any right of setoff, except to and subchapters I and II of chapter 7 of
the extent such right may be affected Title 11 of the United States Code are
under section 553 of Title 11 of the applicable in SIPA proceedings. In addi-
United States Code ... and shall not tion, there is no related bankruptcy case
abrogate the right to enforce a valid, number. Statistical reports to the
nonpreferential lien or pledge against Administrative Office should repeat the
the property of the debtor; and adversary number so that the Statistics
Division will know it is a SIPA matter.
[iv.] may appoint a temporary receiver. Forms B111A (Adversary Proceeding
Opening Report) and B111B (Adver-
15 U.S.C. § 78eee(b)(2)(B)(I–iv) (em- sary Proceeding Closing Report) should
phasis added). be used since this is an adversary pro-
ceeding. For adversary proceedings
In addition, upon the filing of a SIPC within the adversary SIPA proceeding,
application, 11 U.S.C. § 362 comes the clerk’s office should use the original
into effect. adversary proceeding number for the
SIPA provides that the district court related case number.
shall issue a protective decree if the SIPA requires that the bankruptcy
debtor consents, the debtor fails to court hold a hearing with 10 days
contest the application for a protec- notice to customers, creditors, and
tive decree, or the district court finds stockholders on the disinterestedness of
that one of the conditions specified in the trustee or attorney for the trustee.
15 U.S.C. § 78eee(b)(1) exist. If the 15 U.S.C. § 78eee(b)(6)(B). At the hear-
court issues a protective decree, then ing, the court will entertain grounds for
the court will appoint a trustee and an objection to the retention of the trustee
attorney for the trustee whom SIPC, in or attorney for the trustee including,
its sole discretion, specifies. 15 U.S.C. among other things, insider considera-
§ 78eee(b)(3). Upon the issuance of a tions. 15 U.S.C. § 78eee(b)(6)(A). If
protective decree and appointment of a SIPC appoints itself as trustee, it should
trustee, or a trustee and counsel, the be deemed disinterested, and where a
district court shall order the removal of SIPC employee has been specified, the
the entire liquidation proceeding to the employee shall not be disqualified sole-
bankruptcy court in the same judicial ly because of his employment. Id.
district. 15 U.S.C. § 78eee(b)(4). Neither the Bankruptcy Code, Bank-
ruptcy Rules, nor SIPA provide for
REMOVAL TO United States trustee or Bankruptcy
BANKRUPTCY COURT Administrator involvement.
The case is removed to the bankruptcy SIPA provides for noticing of both
court as an adversary proceeding for customers and creditors. The noticing
liquidation. No filing or removal fee is requirements provided for in 15 U.S.C.

56 • SECURITIES INVESTOR PROTECTION ACT

§ 78fff–2(a)(1) are performed by the
trustee, not the clerk of the bankruptcy
court. While SIPA does not require a The purposes of a
formal proof of claim for customers
(other than certain insiders and their rel- SIPA liquidation are:
atives), it does require a written state-
ment of claim. The trustee will normal- (1) to deliver customer
ly provide customers with claim forms
and instructions. The claim form must name securities to or
be filed with the trustee rather than the
clerk of the bankruptcy court. 15 U.S.C. on behalf of cus-
§ 78fff2(a)(2). With limited, specified
exceptions, no claim of a customer or tomers; (2) to distrib-
other creditor can be allowed unless it is
received by the trustee within six ute customer property
months after the initial publication of
notice. 15 U.S.C. § 78fff–2(a)(3). and otherwise satisfy
LIQUIDATION net equity claims of
PROCEEDINGS
The purposes of a SIPA liquidation are: customers; (3) to sell
(1) to deliver customer name securities to
or on behalf of customers; (2) to distrib- or transfer offices and
ute customer property and otherwise sat-
isfy net equity claims of customers; (3) to other productive units
sell or transfer offices and other produc-
tive units of the debtor’s business; (4) to of the debtor’s busi-
enforce the rights of subrogation; and (5)
to liquidate the business as promptly as ness; (4) to enforce
possible. 15 U.S.C. § 78fff(a). To the
extent possible, consistent with SIPA, the the rights of subroga-
liquidation is conducted in accordance
with chapters 1, 3, 5 and subchapters I tion; and (5) to liqui-
and II of chapter 7 of Title 11. 15 U.S.C.
§ 78fff(b). A section 341 meeting of cred- date the business as
itors is conducted by the trustee.
Noncustomer claims are handled as in an promptly as possible.
asset case. Costs and expenses, and pri-
orities of distribution from the estate, are
allowed as provided in section 726 of
Title 11. Funds advanced by SIPC to the POWERS OF THE TRUSTEE
trustee for costs and expenses are The powers of the trustee in a SIPC
recouped from the estate, to the extent case are essentially the same as those
there is any estate, pursuant to section vested in a chapter 7 trustee appointed
507 of Title 11. under Title 11. “In addition, a trustee

SECURITIES INVESTOR PROTECTION ACT • 57

may, with the approval of SIPC but CLAIMS
without any need for court approval: Upon receipt of a written statement of
claim, the trustee promptly discharges
1. hire and fix the compensation of all obligations of the debtor relating to
personnel (including officers and cash and securities by delivering securi-
employees of the debtor and of its ties or making payments to or on
examining authority) and other persons behalf of the customer insofar as such
(including accountants) that are deemed obligations are ascertainable from
by the trustee necessary for all or any books and records of the debtor, or are
purposes of the liquidation proceeding; otherwise established to the satisfac-
tion of the trustee. The value of securi-
2. utilize SIPC employees for all or any ties delivered in this regard are calcu-
purposes of a liquidation proceeding; and lated as of the close of business on the
filing date. 15 U.S.C. § 78fff–2(b).
3. margin and maintain customer The court must authorize the trustee
accounts of the debtor …” to satisfy claims out of monies
advanced by SIPC for this purpose,
15 U.S.C. § 78fff–1(a). notwithstanding that the estate may
not have sufficient funds for such pay-
A SIPC trustee may reduce to money ment. 15 U.S.C. § 78fff–2(b)(1). The
customer securities constituting customer court is generally not involved in the
property or in the general estate of the process except to the extent that a dis-
debtor. 15 U.S.C. § 78fff–1(b). The pute arises between the trustee and cus-
trustee shall, however, deliver securities tomers regarding specific claims.
to customers to the maximum extent Simple objections stay with the initial
practicable. 15 U.S.C. § 78fff–1(b)(1). adversary proceeding. Occasionally,
Subject to prior approval of SIPC, but however, significant litigation arises in
again without any need for court this area which generates related
approval, the trustee may also pay or actions in the form of additional adver-
guarantee any part of the debtor’s sary proceedings.
indebtedness to a bank, person, or other
lender when certain conditions exist. DISTRIBUTION
15 U.S.C. § 78fff–1(b)(2). Customer related property of the
The trustee is responsible for investi- debtor is allocated as follows:
gating the acts, conduct, and condition
of the debtor and reporting thereon to A. First, to SIPC in repayment of
the court. 15 U.S.C. § 78fff–1(d)(1). The advances made to the extent they were
trustee must also provide a statement used to recover securities apportioned
on the investigation to SIPC and to other to customer property;
persons as the court might direct.
15 U.S.C. § 78fff–1(d)(4). Moreover, the B. Second, to customers of the debtor
trustee must make periodic reports to on the basis of their net equities;
the court and to SIPC on the progress of
distribution of cash and securities to cus- C. Third, to SIPC as subrogee for the
tomers. 15 U.S.C. § 78fff–1(c). claims of customers; and

58 • SECURITIES INVESTOR PROTECTION ACT

D. Fourth, to SIPC in repayment of claims in lieu of cash, and to pay all nec-
advances made by SIPC to transfer or essary costs and expenses of administra-
sell customer accounts to another SIPC tion and liquidation of the estate to the
member firm. extent the estate of the debtor is insuffi-
cient to pay said costs and expenses.
15 U.S.C. § 78fff–2(c)(1). Any amount advanced in satisfaction of
customer claims may not exceed
The trustee must deliver customer $500,000 per customer. 15 U.S.C.
name securities to the customer if such § 78fff–3(a). If part of the claim is for
customer is not indebted to the debtor. cash, the total amount advanced for
If indebted, then the customer may, cash payment must not exceed
with the approval of the trustee, reclaim $100,000. 15 U.S.C. § 78fff–3(a)(1).
securities in his name upon payment The difference between cash payments
to the trustee of all such indebtedness. and the maximum amount allowed can
15 U.S.C. § 78fff–2(c)(2). be satisfied by the delivery of securities,
The trustee may, with the approval or cash in lieu of securities.
of SIPC, sell or otherwise transfer
to another member of SIPC, without DIRECT PAYMENT UNDER
consent of any customer, all or any part SIPA OUTSIDE THE
of the account of a customer. 15 U.S.C. BANKRUPTCY COURT
§ 78fff–2(f). The trustee may also enter In certain situations, SIPC may elect to
into any agreement, and SIPC will utilize a direct payment procedure to the
advance funds as necessary, to indemni- customers of a debtor, thereby avoiding a
fy the member firm against shortages trustee and the courts. Certain precondi-
of cash or securities in customer tions must exist. The claims of all cus-
accounts sold or transferred. 15 U.S.C. tomers must aggregate less than
§ 78fff–2(f)(2). In addition, the trustee $250,000, the debtor must be financially
may purchase securities in a fair and distressed as defined in the law, and the
orderly market in order to deliver secu- cost to SIPC for direct payment process
rities to customers in satisfaction of must be less than for liquidation through
their claims. 15 U.S.C. § 78fff–2(d). the courts. 15 U.S.C. § 78fff–4(a).
To the extent customer property and If direct payment is utilized, the
SIPC advances are not sufficient to pay entire proceeding remains outside the
or satisfy in full the net equity claims of court. The process remains essentially a
customers, then customers are entitled transaction between SIPC and the
to participate in the estate as unsecured debtor’s customers.
creditors. 15 U.S.C. § 78fff–2(c)(1). Although SIPA provides for a direct
payment procedure in lieu of instituting
ADVANCES a liquidation proceeding, the bankrupt-
The law requires that SIPC make cy court may still become involved in
advances to the trustee in order to satis- disputes regarding the direct payment
fy claims and otherwise liquidate the procedure. A person aggrieved by a
business. These advances are made to SIPC determination with respect to a
satisfy customer claims in cash, to pur- claim in a direct payment procedure
chase securities to satisfy net equity may, within six months following mail-

SECURITIES INVESTOR PROTECTION ACT • 59

ing of a SIPC determination, seek a final required to fix a time for a hearing on
adjudication of such claim by the court. the application. Notice need not be
15 U.S.C. § 78fff–4(e). The courts hav- given to customers whose claims have
ing jurisdiction over cases under Title been or will be paid in full or creditors
11 have original and exclusive jurisdic- who cannot reasonably be expected
tion of any civil action for the adjudica- to receive any distribution. 15 U.S.C.
tion of such claims. The action is to be § 78eee(b)(5)(B).
brought in the judicial district where the SIPC will review the application and
head office of the debtor is located. It file its recommendation with respect
would be brought as an adversary pro- to such allowances prior to the hear-
ceeding in the bankruptcy court even ing on the application. In any case
though there is no main case. where the allowances are to be paid by
SIPC without reasonable expectation
ROLE OF SECURITIES AND of recoupment and there is no differ-
EXCHANGE COMMISSION ence between the amount applied for
The SEC is responsible for regulating and and the amount recommended by
supervising the activities of the SIPC. The SIPC, the bankruptcy court must
SEC promulgates operating rules which award that amount. 15 U.S.C.
establish the role of self-regulatory orga- § 78eee(b)(5)(C). If there is a differ-
nizations and examining authorities, and ence, the court must, among other
their reporting responsibilities to SIPC of considerations, place considerable
inspections and reviews of its member reliance on the recommendation of
firms. SIPC’s member firms are also SIPC. If the estate is insufficient to
required to provide information and doc- cover these awards as costs of admin-
umentation as necessary to assist in istration, 15 U.S.C. § 78eee(b)(5)(E)
accomplishing these inspections. The provides that SIPC will advance the
penalties for fraud, deceit, or withhold- necessary funds to cover the costs.
ing of information throughout the
processes covered by this law are severe.
15 U.S.C. § 78jjj(c).

COMPENSATION
IN A SIPA ACTION
SIPA specifies that the bankruptcy
court must grant reasonable compensa-
tion for the services and expenses of the
trustee and the attorney for the trustee.
Interim allowances are also permitted.
15 U.S.C. § 78eee(b)(5)(A). Any person
seeking allowances must file an appli-
cation which complies in form and con-
tent with provisions in Title 11, and
must also serve a copy on the debtor,
SIPC, creditors and other persons the
court may designate. The court is

60 • SECURITIES INVESTOR PROTECTION ACT

 LIST OF
Bankruptcy
Terminology TERMS
ADVERSARY PROCEEDING Most debtors who file bankruptcy,
A lawsuit arising in or related to a
and many of their creditors, know
bankruptcy case that is commenced by
filing a complaint with the bankruptcy very little about the bankruptcy
court.
process. The Public Information Series
ASSUME of the Bankruptcy Judges Division is
An agreement to continue performing
designed to provide debtors, credi-
duties under a contract or lease.
tors, judiciary employees, and the
AUTOMATIC STAY general public with a basic explana-
An injunction that automatically stops
lawsuits, foreclosure, garnishments, tion of bankruptcy and how it works.
and all collection activity against the
The series features eight pamphlets
debtor the moment a bankruptcy peti-
tion is filed. that discuss chapter 7 (liquidation),
chapter 13 (adjustment of debts of
BANKRUPTCY
A legal procedure for dealing with debt an individual with regular income),
problems of individuals and businesses;
chapter 12 (adjustment of debts of a
specifically, a case filed under one of
the chapters of title 11 of the United family farmer), chapter 11 (reorgani-
States Code (the Bankruptcy Code).
zation), chapter 9 (adjustment of
BANKRUPTCY debts of a municipality), SIPA (the
ADMINISTRATOR Securities Investor Protection Act),
An officer of the judiciary serving in the
judicial districts of Alabama and North the bankruptcy discharge, and bank-
Carolina who, like the United States
ruptcy terminology. This pamphlet on
trustee, is responsible for supervising
the administration of bankruptcy cases, bankruptcy terminology explains, in
estates, and trustees, monitoring plans
layman’s terms, many of the legal
and disclosure statements, monitoring
creditors’ committees, monitoring fee terms that are used in cases filed
applications, and performing other
under the Bankruptcy Code.
statutory duties.
BANKRUPTCY CODE in business and the debts are for busi-
The informal name for title 11 of the ness purposes.
United States Code (11 U.S.C. §§ 101–
1330), the federal bankruptcy law. CHAPTER 7
The chapter of the Bankruptcy Code
BANKRUPTCY COURT providing for “liquidation,” i.e., the
The bankruptcy judges in regular active sale of a debtor’s nonexempt property
service in each district; a unit of the dis- and the distribution of the proceeds to
trict court. creditors.

BANKRUPTCY ESTATE CHAPTER 7 TRUSTEE

All legal or equitable interests of the A person appointed in a chapter 7 case
debtor in property at the time of the to represent the interests of the bank-
bankruptcy filing. (The estate includes ruptcy estate and the unsecured credi-
all property in which the debtor has an tors. (The trustee’s responsibilities
interest, even if it is owned or held by include reviewing the debtor’s petition
another person.) and schedules, liquidating the proper-
ty of the estate, and making distribu-
BANKRUPTCY JUDGE tions to creditors. The trustee may
A judicial officer of the United States also bring actions against creditors or
district court who is the court official the debtor to recover property of the
with decision-making power over fed- bankruptcy estate.)
eral bankruptcy cases.
CHAPTER 11
BANKRUPTCY MILL A reorganization bankruptcy, usually
A business not authorized to practice involving a corporation or partnership.
law that provides bankruptcy counsel- (A chapter 11 debtor usually proposes
ing and prepares bankruptcy petitions. a plan of reorganization to keep its
business alive and pay creditors over
BANKRUPTCY PETITION time. People in business or individuals
A formal request for the protection of can also seek relief in chapter 11.)
the federal bankruptcy laws. (There is
an official form for bankruptcy peti- CHAPTER 12
tions.) The chapter of the Bankruptcy Code
providing for adjustment of debts of a
BANKRUPTCY TRUSTEE “family farmer,” as that term is defined
A private individual or corporation in the Bankruptcy Code.
appointed in all chapter 7, chapter 12,
and chapter 13 cases to represent the CHAPTER 13
interests of the bankruptcy estate and The chapter of the Bankruptcy Code
the debtor’s creditors. providing for adjustment of debts of
an individual with regular income.
BUSINESS BANKRUPTCY (Chapter 13 allows a debtor to keep
A bankruptcy case in which the debtor property and pay debts over time, usu-
is a business or an individual involved ally three to five years.)

62 • BANKRUPTCY TERMINOLOGY
CHAPTER 13 TRUSTEE DEBTOR
A person appointed to administer a A person who has filed a petition for
chapter 13 case. (A chapter 13 trustee’s relief under the bankruptcy laws.
responsibilities are similar to those of a
chapter 7 trustee; however, a chapter DEFENDANT
13 trustee has the additional responsi- An individual (or business) against
bilities of overseeing the debtor’s plan, whom a lawsuit is filed.
receiving payments from debtors, and
disbursing plan payments to creditors.) DISCHARGE
A release of a debtor from personal lia-
CLAIM bility for certain dischargeable debts.
A creditor’s assertion of a right to pay- (A discharge releases a debtor from per-
ment from a debtor or the debtor’s sonal liability for certain debts known
property. as dischargeable debts (defined below)
and prevents the creditors owed those
COMPLAINT debts from taking any action against
The first or initiatory document in a the debtor or the debtor’s property to
lawsuit that notifies the court and the collect the debts. The discharge also
defendant of the grounds claimed by prohibits creditors from communicat-
the plaintiff for an award of money or ing with the debtor regarding the debt,
other relief against the defendant. including telephone calls, letters, and
personal contact.)
CONFIRMATION
Approval of a plan of reorganization by DISCHARGEABLE DEBT
a bankruptcy judge. A debt for which the Bankruptcy Code
allows the debtor’s personal liability to
CONSUMER BANKRUPTCY be eliminated.
A bankruptcy case filed to reduce or
eliminate debts that are primarily con- DISCLOSURE STATEMENT
sumer debts. A written document prepared by the
chapter 11 debtor or other plan propo-
CONSUMER DEBTS nent that is designed to provide “ade-
Debts incurred for personal, as opposed quate information” to creditors to
to business, needs. enable them to evaluate the chapter 11
plan of reorganization.
CONTINGENT CLAIM
A claim that may be owed by the debtor EQUITY
under certain circumstances, for example, The value of a debtor’s interest in prop-
where the debtor is a cosigner on another erty that remains after liens and other
person’s loan and that person fails to pay. creditors’ interests are considered.
(Example: If a house valued at $60,000
CREDITOR is subject to a $30,000 mortgage, there
A person to whom or business to which is $30,000 of equity.)
the debtor owes money or that claims
to be owed money by the debtor.

BANKRUPTCY TERMINOLOGY • 63
EXECUTORY CONTRACT FRESH START
OR LEASE The characterization of a debtor’s status
Generally includes contracts or leases after bankruptcy, i.e., free of most debts.
under which both parties to the agree- (Giving debtors a fresh start is one pur-
ment have duties remaining to be per- pose of the Bankruptcy Code.)
formed. (If a contract or lease is execu-
tory, a debtor may assume it or reject it.) INSIDER (of individual debtor)
Any relative of the debtor or of a gener-
EXEMPT al partner of the debtor; partnership in
A description of any property that a which the debtor is a general partner;
debtor may prevent creditors from general partner of the debtor; or corpo-
recovering. ration of which the debtor is a director,
officer, or person in control.
EXEMPTION
Property that the Bankruptcy Code or INSIDER (of corporate debtor)
applicable state law permits a debtor to A director, officer, or person in control
keep from creditors. of the debtor; a partnership in which the
debtor is a general partner; a general
EXEMPT PROPERTY partner of the debtor; or a relative of a
Property or value in property that a general partner, director, officer, or per-
debtor is allowed to retain, free from son in control of the debtor.
the claims of creditors who do not
have liens. JOINT ADMINISTRATION
A court-approved mechanism under
FACE SHEET FILING which two or more cases can be admin-
A bankruptcy case filed either without istered together. (Assuming no conflicts
schedules or with incomplete sched- of interest, these separate firms or indi-
ules listing few creditors and debts. viduals can pool their resources, hire the
(Face sheet filings are often made for same professionals, etc.)
the purpose of delaying an eviction or
foreclosure.) JOINT PETITION
One bankruptcy petition filed by a hus-
FAMILY FARMER band and wife together.
An individual, individual and spouse,
corporation, or partnership engaged in LIEN
a farming operation who meet certain A charge upon specific property design-
debt limits and other statutory criteria ed to secure payment of a debt or per-
for filing a petition under chapter 12. formance of an obligation.

FRAUDULENT TRANSFER LIQUIDATION

A transfer of a debtor’s property made A sale of a debtor’s property with the
with intent to defraud or for which the proceeds to be used for the benefit of
debtor receives less than the transferred creditors.
property’s value.

64 • BANKRUPTCY TERMINOLOGY
LIQUIDATED CLAIM PLAINTIFF
A creditor’s claim for a fixed amount of A person or business that files a formal
money. complaint with the court.

MOTION TO LIFT POSTPETITION TRANSFER

THE AUTOMATIC STAY A transfer of a debtor’s property made
A request by a creditor to allow the after the commencement of the case.
creditor to take an action against a
debtor or the debtor’s property that PREBANKRUPTCY
would otherwise be prohibited by the PLANNING
automatic stay. The arrangement (or rearrangement) of
a debtor’s property to allow the debtor
NO-ASSET CASE to take maximum advantage of exemp-
A chapter 7 case where there are no tions. (Prebankruptcy planning typical-
assets available to satisfy any portion of ly includes converting nonexempt
the creditors’ unsecured claims. assets into exempt assets.)

NONDISCHARGEABLE PREFERENTIAL DEBT

DEBT PAYMENT
A debt that cannot be eliminated in A debt payment made to a creditor in
bankruptcy. the 90-day period before a debtor files
bankruptcy (or within one year if the
OBJECTION TO DISCHARGE creditor was an insider) that gives the
A trustee’s or creditor’s objection to the creditor more than the creditor would
debtor’s being released from personal receive in the debtor’s chapter 7 case.
liability for certain dischargeable debts.
PRIORITY
OBJECTION TO The Bankruptcy Code’s statutory rank-
EXEMPTIONS ing of unsecured claims that determines
A trustee’s or creditor’s objection to a the order in which unsecured claims will
debtor’s attempt to claim certain prop- be paid if there is not enough money to
erty as exempt, i.e., not liable for any pay all unsecured claims in full.
prepetition debt of the debtor.
PRIORITY CLAIM
PARTY IN INTEREST An unsecured claim that is entitled to be
A party who is actually and substan- paid ahead of other unsecured claims
tially interested in the subject matter, as that are not entitled to priority status.
distinguished from one who has only a Priority refers to the order in which
nominal on technical interest in it. these unsecured claims are to be paid.

PLAN PROOF OF CLAIM

A debtor’s detailed description of how A written statement describing the
the debtor proposes to pay creditors’ reason a debtor owes a creditor
claims over a fixed period of time. money. (There is an official form for
this purpose.)

BANKRUPTCY TERMINOLOGY • 65
PROPERTY OF THE ESTATE with consumer debts that are secured
All legal or equitable interests of the by property of the estate.
debtor in property as of the commence-
ment of the case. SUBSTANTIAL ABUSE
The characterization of a bankruptcy
REAFFIRMATION case filed by an individual whose debts
AGREEMENT are primarily consumer debts where the
An agreement by a chapter 7 debtor to court finds that the granting of relief
continue paying a dischargeable debt would be an abuse of chapter 7
after the bankruptcy, usually for the because, for example, the debtor can
purpose of keeping collateral or mort- pay its debts.
gaged property that would otherwise be
subject to repossession. SUBSTANTIVE
CONSOLIDATION
SECURED CREDITOR Putting the assets and liabilities of two
An individual or business holding a or more related debtors into a single
claim against the debtor that is secured pool to pay creditors. (Courts are reluc-
by a lien on property of the estate or tant to allow substantive consolidation
that is subject to a right of setoff. since the action must not only justify
the benefit that one set of creditors
SECURED DEBT receives, but also the harm that other
Debt backed by a mortgage, pledge of creditors suffer as a result.)
collateral, or other lien; debt for
which the creditor has the right to 341 MEETING
pursue specific pledged property upon A meeting of creditors at which the
default. debtor is questioned under oath by
creditors, a trustee, examiner, or the
SCHEDULES United States trustee about his/her
Lists submitted by the debtor along financial affairs.
with the petition (or shortly thereafter)
showing the debtor’s assets, liabilities, TRANSFER
and other financial information. (There Any mode or means by which a
are official forms a debtor must use.) debtor disposes of or parts with
his/her property.
STATEMENT OF
FINANCIAL AFFAIRS TRUSTEE
A series of questions the debtor must The representative of the bankruptcy
answer in writing concerning sources of estate who exercises statutory powers,
income, transfers of property, lawsuits principally for the benefit of the unse-
by creditors, etc. (There is an official cured creditors, under the general
form a debtor must use.) supervision of the court and the direct
supervision of the United States trustee
STATEMENT OF INTENTION or Bankruptcy Administrator.
A declaration made by a chapter 7
debtor concerning plans for dealing

66 • BANKRUPTCY TERMINOLOGY
TYPING SERVICE VOLUNTARY TRANSFER
A business not authorized to practice A transfer of a debtor’s property with
law that prepares bankruptcy petitions. the debtor’s consent.

UNITED STATES TRUSTEE

An officer of the Justice Department SOURCES
responsible for supervising the admin-
Doran, Personal Bankruptcy and Debt
istration of bankruptcy cases, estates,
Adjustment, 135–139 (1991)
and trustees, monitoring plans and
disclosure statements, monitoring Griffin, Personal Bankruptcy: What
creditors’ committees, monitoring fee You Should Know, 145–149 (1994)
applications, and performing other
statutory duties.

UNDERSECURED CLAIM
A debt secured by property that is
worth less than the amount of the debt.

UNLAWFUL DETAINER
ACTION
A lawsuit brought by a landlord
against a tenant to evict the tenant
from rental property—usually for non-
payment of rent.

UNLIQUIDATED CLAIM
A claim for which a specific value has
not been determined.

UNSCHEDULED DEBT
A debt that should have been listed by
a debtor in the schedules filed with the
court but was not. (Depending on the
circumstances, an unscheduled debt
may or may not be discharged.)

UNSECURED CLAIM
A claim or debt for which a creditor
holds no special assurance of payment,
such as a mortgage or lien; a debt for
which credit was extended based solely
upon the creditor’s assessment of the
debtor’s future ability to pay.

BANKRUPTCY TERMINOLOGY • 67
Administrative Office of the United States Courts

Thurgood Marshall Federal Judiciary Building

Washington, D.C. 20544

PHONE: (202) 502-1900