Law Block eChapter 26: Bankruptcy Law

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Chapter 26: Bankruptcy Law 51




































Chapter 26: Bankruptcy Law


Learning Objectives


• Identify the core values of the bankruptcy system

• Explore processes and procedures of bankruptcy filings

• Differentiate between Chapter 7, Chapter 11, Chapter 12, and Chapter 13
bankruptcies

• Describe bankruptcy case outcomes

• Review key law changes in bankruptcy

• Detail the role of the paralegal in bankruptcy law


Outline

Section 26.1: Introduction to Bankruptcy

Section 26.2: Consumer Bankruptcy

Section 26.3: Business Bankruptcy

Section 26.4: Bankruptcy Procedure for the Paralegal


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52 Chapter 26: Bankruptcy Law


Introduction


Bankruptcy is a legal procedure established under federal law that allows a financially distressed
individual, business, or municipality to obtain debt relief by either liquidating its assets or restruc-
turing its debt so its creditors may be paid. It is an official, legal declaration of an individual or
business’s inability to meet its financial obligations. The word bankruptcy is a combination of two
Latin terms, bankus and ruptus, with the translated meaning of “broken bench.” Lawyers and
paralegals working in the area of bankruptcy law assist clients through a system created by our
Forefathers as legal and societal relief for the destitute. Perceptions about bankruptcy differ. While
the public may, at times, malign the bankruptcy system as an easy way out for the irresponsible,
the reality is that it provides a very important safety valve for those whose circumstances could
befall anyone of us.


The modern bankruptcy law developed over centuries through a series of enactments and amend-
ments aimed, ultimately, at balancing creditor and debtor interests and preventing abuse of the
system. The most significant recent change to the law came with the enactment of the Bankruptcy
Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which by its drafters’ own
admission, was in many ways designed to make it more difficult to file for bankruptcy. The com-
peting goals of the system, on one hand offering economic relief to struggling debtors, and on the
other hand maintaining economic fairness for creditors and preventing abuse of debt relief poli-
cies, has informed the development of modern bankruptcy laws.

The Bankruptcy Code, a federal statute, is mandatory primary authority and applies to all bank-
ruptcies, regardless of where filed. Some cases decided under the Bankruptcy Code are mandatory
primary authority and others persuasive primary authority, depending on the jurisdiction deciding
the case. There are many variations of bankruptcy that are found within Title 11 of the United
States Code. Bankruptcy under Chapters 7 and 13 are aimed specifically at consumers; Chapter 11
is generally used by businesses; Chapter 12 is directed toward family farmers and fishermen; and,
Chapter 9 is used by municipalities. Proceedings under each Chapter are governed by the general
provisions found elsewhere in Title 11 as well as in the Federal Rules of Bankruptcy Procedure. In
addition to the federal code, local rules have been developed and state laws governing property
rights are often applied.


This Chapter will introduce the core values of the contemporary bankruptcy system, explore the
key players and their respective roles, examine the major elements of the various forms of bank-
ruptcy, and analyze the procedural elements integral to a paralegal’s success in the bankruptcy are-
na.


Section 26.1: Introduction to Bankruptcy


A Brief History

Bankruptcy in the United States, like many bodies of law, traces its origins to English law. Whether
the word ‘bankruptcy’ derives from the Italian banca rotta or the Latin bancus ruptus, the translation is
roughly the same – “broken bench” or “broken table.” The phrase signified the practice of break-


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Chapter 26: Bankruptcy Law 53
ing a merchant’s bench, or table, when nonpayment
of his debts made him no longer welcome to do KEY TERMS
business with the other merchants. Like the histori-
cal practice of breaking an insolvent merchant’s
bench, bankruptcy under English law was involun- Bankruptcy
tary; bankruptcy was a creditor’s collection device, A federally authorized legal proceed-
used to take possession of the entirety of the debt- ing through which a debtor is relieved
or’s property and divide it equally among his credi-
tors. The benefit to the debtor was the release of any of total or partial liability for its debts
unpaid debts. Later, insolvency law developed, (discharge) by making court-approved
which was voluntary relief for the debtor. Insolvency arrangements for their partial repay-
law did not release the debtor of his unpaid debts, ment through liquidation of the debt-
but discharged him from debtors’ prison. or’s assets, restructuring of the debt
instruments, or reorganization of the
debtor business.
In the United States, there is constitutional recogni-
tion that a unified debtor-creditor statute, combining
the elements of bankruptcy and discharge, is within the national interest. Article I, Section 8,
Clause 4 of the U.S. Constitution provides that Congress shall have the power “[t]o establish ...
uniform Laws on the subject of Bankruptcies throughout the United States.” Despite that recogni-
tion, it was not until 1800 that insolvency and bankruptcy were combined in a uniform act of Con-
gress. The Bankruptcy Act of 1800 was extremely short-lived, as it was repealed in 1803, two years
prior to its statutory expiration. Then, in 1841, Congress enacted another bankruptcy statute which
was also repealed just three years later in 1844. Another attempt to strike an appropriate balance
between insolvency and bankruptcy law was enacted with the Bankruptcy Act of 1867. This act
was extensively amended in 1874, only to be repealed just like its predecessors in 1878. Finally, in
1898 the competing interests were accommodated. The Bankruptcy Act of 1898 (‘The Act’) creat-
ed bankruptcy courts, adopted the term “trustee” to describe the creditors’ representatives, adopt-
ed state exemptions, and so began the emergence of modern bankruptcy law. The Act was amend-
ed several times over the years, most notably with The Chandler Act, adopted in 1938, until it be-
came obvious that it was out of date
and needed more invasive restructur-
ing. The Bankruptcy Reform Act of
1978 (‘The Code’) marked such a re-
structuring and is the true introduction
of contemporary bankruptcy law. The
Code introduced four operative chap-
ters – Chapters 7, 9, 11, and 13 – each
dealing with a different type of bank-
ruptcy case, as well as the universal
chapters – Chapters 1, 3, and 5 – ad-
dressing definitions, general provi-
sions, case administration, and the like.
The Code has been amended several
times since its enactment, largely in
small and technical details, however, a
few amendments warrant mention.



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54 Chapter 26: Bankruptcy Law

First, in 1986, a new operative chapter was cre-
NOTEABLE & ated – Chapter 12 – that was reserved for the
family farmer. Second, in 1994, dollar amounts
QUOTABLE within the Code were tied to changes in the
Consumer Price Index. Finally, the Bankruptcy

Abuse Prevention and Consumer Protection
“[B]ankruptcy is about financial death and Act of 2005 (BAPCPA) represents the most sa-
financial rebirth. Bankruptcy is the great lient modern changes to the Code. The goals of
American story rewritten. We’re a nation of BAPCPA were to prevent abuse of the Code by
debtors.” individual debtors by creating stricter eligibility
standards, modifying Chapter 12 to include
- Elizabeth Warren, family fishermen and eliminating the sunset
Interview with PBS Frontline provisions, and creating an additional chapter –
for Secret History of the Chapter 15 – for Ancillary and Other Cross-
Credit Card (2004) Border Cases. The difficulty in enacting and
maintaining a uniform bankruptcy act, as evi-
denced by the law’s sporadic existence and fre-

quent repeal and replacement, is in large part due to the competing interests of the law; competing
interests that historically were addressed in two separate bodies of law – bankruptcy and insolven-
cy.

The Competing Interests of Bankruptcy Law

As we saw in the historical development of bankruptcy law in the United States, the competing in-
terests of bankruptcy law have historical roots in two separate bodies of law –bankruptcy law and
insolvency law. Debtor’s prison, mentioned above, is precisely what it sounds like, a prison for
people unable to pay their debts, and was a common method of dealing with unpaid debt in West-
ern Europe and the United Stated through the mid-19 century. In the United States, debtor’s
th
prisons were outlawed at the federal level in 1833. It is notable that this abolition coincides with
the advent of uniform bankruptcy laws in the U.S., no matter how short-lived those statutes were.
These separate bodies of law serve to illustrate the competing interests of bankruptcy law, both
past and present. The question has always been, and will always be, how should a unified bank-

ruptcy law balance the interests of the creditor
versus the interests of the debtor.


Bankruptcy has long had a negative stigma as-
sociated with the irresponsibility of the debtor,
drawing from the idea that if a debtor was fi-
nancially responsible they would always be able
to pay their debts. The debtor agreed to pay
their creditor, and in most cases received some-
thing of value for such an agreement, so a
debtor that cannot follow through on their end
of the bargain is somehow dishonorable. They
have broken a contract and, worse yet, they



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Chapter 26: Bankruptcy Law 55

have broken their word. Then there is
the creditor to consider. This is a cap-
italist society and people in the busi-
ness of granting loans would be se-
verely disadvantaged in the market if
those to whom they lent could simply
ETHICAL COMPASS get away with not paying them back
due to financially irresponsible. Even
As a paralegal, you will encounter individuals from all worse, no one in a free market gov-
economic backgrounds with varied motivations. Some erned by laws protecting a debtor
of the firm’s bankruptcy clients will be going through from repaying their debts could trust
the hardest times of their lives at no fault of their own. the word of anyone else; no credit
Others may be trying to work the system, purposely would ever be extended, and if it
living beyond their means knowing they can file for were, the cost of such credit would be
astronomical; contracts would be ren-
bankruptcy for the third or fourth time. Part of your job dered useless. And, even if there was
will be to identify the red flags of systemic abuse while a legitimate reason for protecting
simultaneously exhibiting empathy for their situation debtors, protecting creditors against
within legal and ethical parameters. systemic abuse still presents a prob-
lem.

The truth is, our economy is, in many ways, built on credit, and economic prosperity comes and
goes in waves– no one is the master of the circumstances in which they find themselves. The three
largest reasons for filing bankruptcy are job difficulties, medical problems, and family breakups –
all unpredictable contingencies.


Every enactment and amendment to the various bankruptcy statutes adopted since 1800 have
been a representation of these compet-
ing interests, and have cut one direction
or the other until a reasonable balance
was struck. Changing political tides will
always call into question whether the
law, as it currently exists, continues to
strike that reasonable balance.

The Goals of the
Bankruptcy System

Given the history of the bankruptcy
system and the competing interests it is
intended to serve, the goals of the sys-
tem are relatively straightforward. There
are two classic goals of bankruptcy.
First, is to provide a fair and equitable distribution of the debtor’s assets for the benefit of all cred-
itors. Second, is to give debtors a “fresh start,” relieved from the burden of unmanageable debt, to
facilitate a return to economic productivity.




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56 Chapter 26: Bankruptcy Law
A debtor’s goals as they enter bankruptcy are
twofold: they want to be discharged from as
many debts as possible while simultaneously
preserving ownership of as much property free
from debt as possible. The goals of the credi-
tors and trustee in a bankruptcy case are like- WHAT DO YOU THINK?
wise twofold, and predictably adverse to the
goals of the debtor. They want to maximize the Do you think the general stigma surrounding
total distribution to the various creditors while bankruptcy is warranted?
ensuring that the debtor does not receive a dis- Whose economic position is more in need of
charge unless they are legally entitled to one. protection, the debtor or the creditor?

In a capitalist democratic republic is “need of
As you will see in the ensuing discussion, the protection” an appropriate consideration?
goals of the system are served differently de-
pending upon the type of bankruptcy that has
been initiated. In Chapter 7 bankruptcy, the liq-
uidation chapter, the debtor (consumer or busi-

ness) relinquishes their rights to all non-exempt assets, which are then sold and the proceeds are
distributed pro rata to the creditors. The benefit to the debtor is that they receive a discharge of
any remaining unpaid portion of their dischargeable debts. Property exemptions are relatively lim-
ited, so the debtor seldom retains possession of much more than a vehicle, items of sentimental
value, furniture, and sometimes a home of very low value. Notwithstanding the debtor’s limited re-
tention of property, the debtor receives a fresh start free from unmanageable debt, and creditors
receive an equitable distribution of the debtor’s property.


In Chapters 13 (consumers) and 11 (businesses), the
KEY TAKEAWAYS debtor has a much greater opportunity to retain posses-
sion of their property. Instead of liquidating assets, in
The development of the modern Chapters 13 and 11, a payout plan is proposed to pay off
bankruptcy system is continuously debts out of future income. Chapter 13 has gained im-
informed by: portance in recent years because not only does the debt-
or often get to retain ownership of a larger portion of
 The balancing of the competing their property, but because the majority of consumer
interests of the debtor and the cases are “no asset” cases. “No asset” cases are those in
creditor which no non-exempt property exists for sale and distri-

 The achievement of societal bution. Therefore, it is in the creditors’ interests to re-
goals, i.e. providing debtors with ceive at least some small payout in Chapter 13 as op-
a fresh start, and equitably posed to nothing in Chapter 7.
distributing property to
creditors As a paralegal working in the bankruptcy field, it is im-
portant to remain mindful of the goals of the bankruptcy
 The achievement of individual
goals, i.e., the retention of system. If working for an attorney who works for a client
property by the debtor vs. who has the goals of a debtor, you must be able to help
maximizing the payout for achieve those goals, while navigating the adverse goals of
creditors the client’s creditors.



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Chapter 26: Bankruptcy Law 57

The Sources of Bankruptcy Law

Bankruptcy law is very much a niche practice, Hierarchy of Court Authority:
in part because of the technical knowledge Bankruptcy
required to competently navigate its varied
nuances, but also, in part, due to the source
of law. Bankruptcy law is generally federal
law. When we speak of the Code, we are talk-
ing about federal statute, specifically Title 11
of the United States Code. In Title 11, Chap-
ters 1, 3, and 5 are considered the universal
chapters insomuch as they apply to all bank-
ruptcy cases. Chapters 7, 9, 11, 12, 13, and 15
of Title 11 are referred to as the operative
chapters, each setting forth a different type of
bankruptcy. Chapter 7 is asset liquidation and Figure 1
can be used by consumers or businesses.
Chapter 9 is reserved for municipalities.
Chapter 11 is reorganization and, while available to individuals, is the chapter of choice for busi-
nesses. Chapter 12 is reserved for family farmers and fishermen. Chapter 13 is the debt restructur-
ing chapter for consumers. And, finally,
Chapter 15, added by BAPCPA in 2005,
is for ancillary and other cross-border
PRACTICE ON POINT cases.

In addition to the Code, there are the
Federal Rules of Bankruptcy Procedure
which are subdivided into nine parts cov-
ering everything from commencement,
As a paralegal working in the bankruptcy arena, officers and administration, notices, and
you should be able to locate applicable meetings, to claims and distributions,
debtors’ duties, collection and liquidation
bankruptcy law, as well as relevant forms, in
your jurisdiction. of the estate, and the appeals process.
The Federal Rules of Bankruptcy Proce-
dure also authorize United States district
• Title 11 – a solid free resource, can be found
here. courts and bankruptcy courts to write
their own rules to implement the Code
• Federal Rules of Bankruptcy Procedure can be and Federal Rules of Bankruptcy Proce-
found here. dure. These are known as local rules, and

• Local rules can be found on the corresponding can generally be found on each respective
court’s website court’s website. Then there is case law,
which guides and sometimes dictates the
• Official bankruptcy forms can be found here. court’s application and interpretation of
• State laws can often be found on the state the statutes and rules of procedure. The
government’s website hierarchy of court authority in the bank-
ruptcy field is illustrated in Figure 1.



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58 Chapter 26: Bankruptcy Law

Outside of the federal statute and federal rules of procedure, the courts will sometimes be called on
to apply state law. While there are no state bankruptcy codes, bankruptcy proceedings can fre-
quently involve issues of state property law. This can take the form of recording statutes, lien theo-
ries, and foreclosure, among many others. Another important application of state law is state prop-
erty exemptions. While §522 of the Code contains the federal exemptions, states have their own
separate set of property exemptions. The Code allows the debtor to choose between the different
sets of exemptions, based on what would best benefit the debtor; however, several states have en-
acted legislation prohibiting the debtor from choosing exemptions on the federal list, thereby forc-
ing the decision.


In the end, what initially seems to be a straightforward legal field operating solely in the federal
realm turns into something quite different. Due to the application of such varied state laws and the
promulgation of local rules, it is unhelpful to generalize certain bankruptcy issues. Each jurisdiction
could have a vastly different outcome on the same set of facts. It is important, as a paralegal, to ap-
prise yourself of the rules and laws
applicable in your jurisdiction. What
follows is an account and discussion
of the pervasive themes, rules, and
procedures that can be found
throughout the universal and opera-
tive chapters of Title 11.
CASE CONNECTION
Section 26.2:
Consumer



Bankruptcy

Andrews University v. Merchant
While the central divide in bankrupt-
th
958 F.2d 738 (6 Cir. 1992) cy law is between consumer and
business bankruptcies, it is far from a
sharp distinction. Many individuals
Issue: “[W]hether in refusing to provide a student enter bankruptcy proceedings as en-
-debtor their educational transcript because they trepreneurs whose small businesses
are in default on a prepetition debt, a school are failing. Many business bankrupt-
violates the automatic stay provision.”
cies are sole proprietorships or small
partnerships. Nevertheless, develop-
ments in commercial law, particularly
Held: Yes. “While many of the exceptions to the drafting and adoption of the
discharge found in 11 U.S.C. §523 are exceptions
from the automatic stay...education loans are Uniform Commercial Code (UCC),
make it sensible to tackle bankruptcy
not. Thus, the automatic stay applies to creditors
of education loans and remains in effect until (1) along this divide. Consumer bank-
ruptcies are characterized by their
the case is closed, (2) the case is dismissed, or (3)
a discharge is granted or denied.” high volume, routine procedures,
and the role of the paralegal. Studies
show that more than one million or-

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Chapter 26: Bankruptcy Law 59
dinary citizens enter bankruptcy each year. In contrast, business bankruptcies tend to be of a more
bespoke nature and involve extensive negotiation and litigation. We will begin our look at consum-
er bankruptcies with an element common to all consumer filings.

The Automatic Stay
Like many legal proceedings, bankruptcy proceedings begin with the debtor, by and through coun-
sel (and his or her paralegals), filing a petition. At the moment that petition is received by the court
clerk, the filing fee is paid, and the petition is date-stamped, two things are triggered: a bankruptcy
estate is created, and an automatic stay on all collection actions against the debtor is put into place.
That means all attempts made by the debtor’s creditors to collect must stop – no more phone calls,
ongoing collection suits are put on hold, foreclosure proceedings halt. The automatic stay does not,
however, stop ancillary proceedings, i.e., proceedings that are not direct attempts to collect on a
debt. These ancillary proceedings include, but are not limited to, actions to establish or modify do-
mestic support obligations, actions regarding child custody, or actions enforcing the payment of
child support.


The bankruptcy court has discretion to lift the stay during proceedings, and has been known to do
so under certain circumstances, particularly for secured creditors. However, creditor attempts to

circumvent the automatic stay by resorting to self-help measures violate statute and procedure,
even if the court would have lifted the stay under the circumstances. Consider Nissan Motor Ac-
ceptance Corp. v. Baker, 239
B.R. 484 (N.D. Tex. 1999), in
which a creditor repossessed
a debtor’s vehicle without
knowledge of the fact that
the debtor had filed for
bankruptcy. Upon notice of
the bankruptcy proceedings,
instead of returning the vehi-
cle, the creditor retained pos-
session of the vehicle and
sold it. The debtor then
sought damages for violation
of the automatic stay. The
court maintained that “a
creditor’s continued reten-
tion of estate property after
notice of a bankruptcy filing constitutes an ‘exercise of control’ over property of the estate in vio-
lation of the automatic stay,” and that a creditor has an obligation “to return estate property unless
it is of inconsequential value to the estate.” The court further held that “nothing in [the statute] re-
quires the debtor to provide the creditor with adequate protection as a condition precedent to
turnover.” Finally, the court found that the creditor had willfully violated the stay by selling the ve-
hicle after being given notice of the bankruptcy and without an order from the court. In acting on
its own without permission from the court, the creditor was charged nearly $30,000 in damages.




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60 Chapter 26: Bankruptcy Law

Chapter 7: Liquidation
Chapter 7 bankruptcy is what most indi- KEY TAKEAWAYS
viduals think of when they think of bank-
ruptcy. It involves the collection of all the
debtor’s property, the sale thereof, and the Bankruptcy Estate
subsequent distribution of the proceeds to
creditors. It is the Trustee in Bankruptcy’s
(TIB) job to do this. The TIB must deter- Under 11 U.S.C. §541, all property owned by the
mine if any property in the estate is en- debtor at the commencement of the case
cumbered by another interest in the prop- becomes “property of the estate.” The statute also
erty. This might take the form of co- includes, in the estate, certain property acquired
ownership, but more frequently, it comes by the debtor within 180 days after filing the
in the form of a secured party. In such cas- petition.
es, the trustee will deduct from the pro- Importantly, the estate does not include post-
ceeds, his or her own fee and any costs of petition wages earned by the debtor. There are
sale, then distribute that part of the pro- also certain exceptions from the estate including,
ceeds to which the secured party is enti- but not limited to, funds placed in an education
tled. Any remainder of the proceeds is put IRA for the benefit of a child or grandchild, and
into a pool for distribution to general cred- amounts withheld by employers as contributions
itors. The TIB must also determine the va- to an employee benefit plan.
lidity of any exemptions claimed by the
debtor. Valid exemptions determine what
property of the estate, if any, is exempt from sale and will be retained by the debtor. The TIB will
then make distributions to the three groups of general creditors. Those groups are “priority credi-
tors,” “general, unsecured creditors,” and “subordinated creditors.” Imagine a line of creditors
standing before the trustee, each owed something by the debtor. It is the TIB’s job to determine
the appropriate order of that line, i.e. who gets paid first, and how much each one of them gets.























This is the basic foundation of Chapter 7 bankruptcy, the baseline of the entire bankruptcy system.
We have already learned that such a system is rife with opportunities for abuse. Indeed, the balance
between broad versus limited access to Chapter 7 bankruptcy is one element of the system that has
received an enormous amount of attention, as the tensions between the competing interests of
bankruptcy ebb and flow.

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Eligibility and the Means Test
Eligibility for access to the first bankruptcy laws PRACTICE ON POINT
was limited only to “traders,” but it was not
long before access to bankruptcy laws included
both businesses and individuals. Prior to the
Great Depression, only liquidation bankruptcy
was available. With the advent of the repayment
option, debtors had a new choice, but the 1978 A major role of the paralegal in the
Bankruptcy Code kept access to liquidation rela- bankruptcy field will often be information
tively broad. A Congressional decision to incen- gathering. At the beginning of the client
relationship, it is vital to gather as much
tivize Chapter 13 filings saw changes adopted to information as possible.
that section of the law, with initial success. How-
ever, the frequency of Chapter 13 filings varied • The two most important things to learn are
greatly among jurisdictions. A spike in bankrupt- the extent and exact nature of the client’s
cy filings beginning in the early 1980s, and suc- property and debts, and whether they have
cessful lobbying from the credit industry, filed for bankruptcy in the past
spurred Congress to give bankruptcy judges the
power to dismiss Chapter 7 filings if there was • Ask about specifics. Don’t just ask, “what
evidence of “substantial abuse.” The various are your assets?” and “what are your
courts’ application of this statutory power led to debts?” Ask if the client has life insurance,
many debtors being denied access to Chapter 7 retirement funds, or a trust; ask about
credit cards, mortgages, and law suits, etc.
at the outset of their filing, or their Chapter 7
case being converted to Chapter 13. Ultimately, the desire to prevent abuse and limit access to liq-
uidation bankruptcy culminated in the 2005 amendments to the code – BAPCPA.



11 U.S.C. §707(2)(A)(i) contains what is
known as the “means test.” The means test
ETHICS CHECK creates a presumption of abuse for any filer
whose current monthly income, less certain
monthly expenses and multiplied by 60, is
If you are the point person in the law office for
initial contact with potential clients, you should greater than statutorily defined thresholds.
always run a conflict check before delving too The times 60 multiplier represents an esti-
deeply into a client’s issues. In some offices, this will mated disposable income over a period of
not be your responsibility, but in smaller firms it five years. Leaving some discretion to the
may well be. If it is your responsibility it is courts, §707 also includes provisions for de-
absolutely imperative that you follow your office’s termining abuse without the presumption
procedure for doing so. This process will determine created by the means test, including both a
whether or not your firm will be able to take on the bad faith and a totality of the circumstances
client. Generally, this is less of an issue in analysis to be applied on a case-by-case ba-
bankruptcy cases, but is a procedure you should be sis. If abuse is found to exist, either under
familiar with. the means test, or the court’s discretion, the
Chapter 7 case can be dismissed or convert-
ed to another operative chapter.





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62 Chapter 26: Bankruptcy Law
The means test boils down to a two-part analysis. First, if your client’s (the debtor’s) monthly in-
come is at or below the median income for a household of your client’s size in your state, they pass
– there is no presumption of abuse and they can proceed in Chapter 7. If, however, your client’s in-
come is above the median, a more complicated analysis ensues. If your client’s disposable income is
below $6,000 there is no presumption of abuse and they can proceed in Chapter 7. If your client’s
disposable income is above $10,000 there is a presumption and the case will either be dismissed or
converted to Chapter 13. If your client’s disposable income is between $6,000 and $10,000 a sec-
ondary abuse computation is triggered. If your client’s disposable income is greater than 25% of
their non-priority, unsecured claims, then there is a presumption of abuse and the case will either
be dismissed or converted to Chapter 13. If your client’s disposable income is less than 25% of
their non-priority, unsecured claims, then there is no presumption of abuse and they may proceed
in Chapter 7.


Suffice it to say, the means test is complicated and the subject of substantial litigation. Its purpose
was twofold; protect against abuse of the bankruptcy system while safeguarding bankruptcy filers
from abusive application of vague court doctrines. The undercurrent of this balancing act is that
Congress determined it is in the best interest of the country to limit access to Chapter 7 bankrupt-
cy. As a paralegal working in the field, a solid grasp of this calculation could prove invaluable to an
employer.



Property
Exemptions

Your client has filed their
bankruptcy petition, a
bankruptcy estate has been
created, a trustee has been
appointed, the automatic
stay is in effect, and the
means test has shown that
your client is eligible for
Chapter 7 relief. The next
concept to cover is exempt
property.


11 U.S.C §522 states that “an individual debtor may exempt from property of the estate the prop-
erty listed in either” the federal statute or under state law. As was mentioned earlier in the Chapter,
many states have promulgated their own set of bankruptcy property exemptions. These state ex-
emptions vary, but often take on a similar tone to those in the federal statute. Some states offer
greater property protection for debtors, while others offer less. In many cases, state law prohibits
debtors from taking the federal exemptions which, in essence, forces the debtor to use the state
exemptions. In all other states, the debtor may make an election under §522 to use either the fed-
eral exemptions or the state exemptions. A debtor may not, however, mix and match exemptions
from both the state and the federal statutes. To get an idea of what property society and the legis-
lature has deemed fit for preservation in order for a debtor to truly get a fresh start, review §522(d)



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Chapter 26: Bankruptcy Law 63










CASE CONNECTION








Often, exemption disputes take the form of classification issues.


In re Johnson
14 B.R. 14 (Bankr. W.D. Ky. 1981)


Issue: “Is a bus a bus, or is it a car?”


Held: “Reluctantly we conclude that it is a car ... we find with conviction that a motor
vehicle is a motor vehicle, and not necessarily an automobile. We expressly reserve, until it is
properly presented, any consideration of the reverse proposition that an automobile is neither a
bus nor a motor vehicle.”


of the statute. Keep in mind that the dollar amounts within the statute are constantly in flux and
often vary year to year.
KEY TERMS
Theoretically, when strategically utilized
and coupled with discharge, the exemp-
tions offer the debtor the ability to retain Collateral: Property pledged as security for
enough property to emerge from bank- the repayment of a loan
ruptcy in a position to start economically
anew. Unsecured Creditor: A creditor whose loan is
not protected by attachment to collateral
Claims and Distributions Secured Creditor: A creditor whose loan is
protected by attachment to collateral
Our analysis of Chapter 7 bankruptcy has,
thus far, had a debtor-centric perspective. Under-secured: A secured creditor where the
Now that the trustee has collected the value of the loan is greater than the value of
property of the bankruptcy estate and de- the collateral
termined what property will remain in the
client’s possession based on their election Over-secured: A secured creditor where the
of the federal exemptions, the trustee’s value of the loan is less than the value of the
focus will, as will ours, turn to the credi- collateral


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64 Chapter 26: Bankruptcy Law
tors. Unless it is a “no asset” case, creditors are sent a proof of claim form (Form 410) which in-
cludes the requirement to attach whatever writing the claim is based on. A creditor must file a
proof of claim form in order to be eligible to receive a distribution from the bankruptcy estate,
even if the creditor was listed on the debtor’s schedules, and all claims must generally be filed with-
in 90 days of the first meeting of creditors. Unless an interested party objects, contesting the validi-
ty or value, a claim is allowed.


The major difference between secured and unsecured claims is the allowance of post-petition inter-
est. Both secured and unsecured claims are entitled to pre-petition interest, or interest accrued be-

fore the debtor filed for bankruptcy, as-
suming the debt instrument so provided.
This accrued interest would be a part of
the claim submitted on Form 410. Unse-
cured creditors are not, however, allowed
to add post-petition interest to their claim.
Secured creditors, on the other hand, are
allowed to add post-petition interest to
their claim, up to the value of the collat-
eral. So, under-secured creditors cannot
claim post-petition interest because the
value of their claim without such an addi-
tion already exceeds the value of the col-
lateral. An under-secured creditor is con-
sidered partially secured and their claim becomes bifurcated in the claims process.

Distributions from the estate follow the pattern that has already been introduced but bears repeat-
ing. First, secured creditors are paid from the proceeds from sale of the collateral by which their
claim was secured. If there are excess proceeds, they get placed into the pool to be distributed to
the unsecured creditors. Distribution is then made to priority, unsecured creditors, in full if there is
sufficient property to do so. Claim priorities can
KEY TAKEAWAYS be found in §507 of the code and can be exam-
ined in detail here. Assuming something is left
after payment of secured and priority, unse-

Partially Exempt Property cured creditors, the remaining funds get distrib-
uted to general, unsecured creditors pro rata.

Redemption, Reaffirmation, and
What happens when the statutory limit on the
value of exempt property is less than the fair Discharge
market value of the property? Answer: it is Discharge of debt, the ultimate purpose of
partially exempt property. Chapter 7 bankruptcy from the perspective of
In such cases, the property is usually sold, and the debtor, is not a right. Discharge may be
the proceeds are distributed accordingly, i.e. challenged by either the trustee or a creditor un-
the debtor receives the value equal to the der one of two statutory provisions, §523 or
exemption limitation and the excess enters the §727. Section 523 renders only one particular
distribution pool. debt nondischargeable; these are considered the


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Chapter 26: Bankruptcy Law 65

exceptions to discharge. Section 727
renders all debts nondischargeable.


Section 523 exceptions from HOT TOPICS
discharge are a matter of policy
considerations. Debts such as Student loan debt is nondischargeable under § 523
recent back income taxes, do-
mestic support obligations, and “unless excepting such debt from discharge ... will
student loans are nondischargea- impose an undue hardship on the debtor and the
ble. Section 523 also includes debtor’s dependents.” 11 U.S.C. §523(a)(8). There
exceptions from discharge re- are two undue hardship tests in use, the most popu-
garding debts associated with lar of which is the Brunner test. The debtor must
false pretenses or fraud on the show:
part of the debtor. Section 727  That the debtor cannot maintain, based on cur-
prevents discharge, largely in rent income and expenses, a “minimal” standard
cases of abuse characterized by of living for herself and her dependents if forced
more offensive forms of fraud to repay the loans;
and presenting false claims. Sec-
tion 727 also prevents a debtor  That additional circumstances exist indicating
from receiving a discharge in a that this state of affairs is likely to persist for a
case commenced within eight significant portion of the repayment period of
years from the filing of a previ- the student loans; and
ous bankruptcy petition in
which a discharge was granted.  That the debtor has made good faith efforts to
repay the loans
This provision is aimed at pre-  Brunner v. New York State Higher Education Ser-
venting irresponsible or abusive vices Corp., 831 F.2d 395 (2d Cir. 1987)
debtors from taking advantage of
the system too frequently.


Assuming the client has no debts falling into the exceptions in §523, has not received a discharge in
the previous eight years, and there are no claims of fraud, he or she will be discharged of any debts
not paid after the distribution of the bankruptcy estate. Creditors take what they can, write-off the
loss, and the debtor gets his or her
fresh start. Sometimes, however,
there is property the debtor wants
to retain but cannot sufficiently ex-
empt. There are two other im-
portant concepts that affect dis-
charge and the debtor’s ability to re-
tain certain property that they can-
not otherwise exempt from the es-
tate: redemption and reaffirmation.






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66 Chapter 26: Bankruptcy Law

Redemption, found under §722, is an important provision but one that is not often used simply
because the debtor lacks the financial means. Redemption is the act of paying a lien holder the
amount of the allowed secured claim – basically paying off the debt outside bankruptcy. Since
many debtors lack the means to do this, there is often some maneuvering between family mem-
bers to try and get help keeping certain prized possessions. The stipulations of the provision are
that, in order to redeem, the property must be 1) tangible personal property, 2) primarily for per-
sonal, family, or household use, 3) from a lien securing a dischargeable consumer debt, and 4) ex-
empted §522.


Reaffirmation is a more flexible option and can be found under §524(c). Reaffirmation is an agree-
ment between a debtor and creditor to not discharge a debt. This will often be done in considera-
tion for the debtor’s continued use and ownership of collateral associated with the debt. In order
to appropriately reaffirm a debt 1) the agreement must have been made prior to discharge, 2) the
debtor must receive certain disclosures, and 3) the agreement must be filed with the court, accom-
panied by a declaration or affidavit from the debt-
or’s attorney stipulating that the debtor was fully in- KEY TERMS
formed and that it is a voluntary agreement, that the
agreement does not impose an undue hardship on
the debtor, and that the attorney fully advised the Partially Secured Creditor
client of all the legal consequences of the agreement.
The debtor must also not rescind the agreement
within 60 days of filing it with the court or any time A creditor is partially secured when
before discharge, whichever is first. Reaffirmation is the value of the loan is greater than
a route sometimes taken by debtors to maintain the value of the collateral.
ownership of their home when they are unable to
exempt enough of its value.



Chapter 13: Restructuring

Whereas Chapter 7 debtors pay off as much
of their debt as possible through the sale of
nonexempt assets, Chapter 13 focuses on the
use of future income to pay down debts. In
Chapter 13, the debtor keeps all their prop-
erty in exchange for handing over a portion
of their income for no less than three years.
It is the debtor’s responsibility to propose a
detailed repayment plan to the bankruptcy
court, which then must be approved. Upon
completion of the repayment plan, any re-
maining obligations are discharged, achieving
the debtor’s fresh start.







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Chapter 26: Bankruptcy Law 67

Eligibility and the KEY TERMS
Means Test in Chapter
13
Purchase-Money Security Interest
To be eligible to file for bank-
ruptcy under Chapter 13, an indi- A purchase-money security interest, or PMSI, is a se-
vidual must be a natural person curity interest created in collateral that was purchased
and meet the requirements of with the proceeds of the loan. Common examples of
who may be a debtor under §109 PMSIs are home mortgages and car loans.
(e) of the code. That section
maintains that, in order to qualify In contrast, a non-PMSI is a security interest created in
collateral that was not purchased with the loan pro-
for Chapter 13 bankruptcy, the ceeds. One such example is a home equity line of
individual must have 1) regular credit.
income, 2) noncontingent, liqui-
dated, unsecured debts of less than $250,000, and 3) noncontingent, liquidated, secured debts of
less than $750,000. Im-
portantly, co-debtors can be
included in Chapter 13 pro-
ceedings.

The means test also plays a
role, but not so much on el-
CASE CONNECTION igibility as it does for Chap-
ter 7 cases. Instead, the re-
sults of the first part of the
means test of Chapter 13
dictates the length of the re-
payment plan. For debtors
above the median income
Associates Commercial Corp. v. Rash for a household of the debt-
or’s size in the debtor’s
520 U.S. 953 (1997)
state, the repayment plan

cannot exceed a period of
Issue: “[W]hen a bankrupt debtor has exercised the ‘cram
down’ option ... is the value of the collateral to be five years. For debtors be-
low the median income, the
determined by (1) what the secured creditor could obtain
through foreclosure sale of the property (the ‘foreclosure repayment plan must pro-
sale’ standard); (2) what the debtor would have to pay for vide for a term that is no
comparable property (the ‘replacement value’ standard); longer than three years, un-
or (3) the midpoint between these two measurements?” less the court has reason to
approve a longer term. The

Chapter 13 means test pro-
Held: “[T]he value of the property (and thus the visions can be found at
amount of the secured claim under §506(a)) is the 11U.S.C. §1322(d)(1). Other
price a willing buyer in the debtor’s trade, business, than these differences on el-
or situation would pay to obtain like property from a igibility, a Chapter 13 case
willing seller.” (the replacement value). commences in the same way


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68 Chapter 26: Bankruptcy Law
a Chapter 7 case does, with the filing of the petition. The proposed plan must be filed within four-
teen (14) days of filing the petition.

Payments to Secured Creditors

One of, if not the most common reason for electing Chapter 13 over Chapter 7 is the debtor’s de-
sire to maintain ownership and possession of property that is the subject of a secured loan. As was
the case in Chapter 7, secured creditors are afforded significantly greater protection in Chapter 13
than their unsecured counterparts. The creditor is likely to have declared the debtor in default on
the loan and demanded repossession of the collateral. The debtor wants to avoid that. The determi-

nation of whether a debtor may maintain possession of the collateral depends on the debtor’s abil-
ity to comply with the Chapter 13 provisions designed to protect creditors from the loss of the
collateral or a decline in its value. Two issues that arise in this context are adequate protection and
adequate payment. Adequate protection refers to cash, a replacement lien, or insurance on the
property to protect the creditor from the abovementioned forms of risk. Adequate payment refers
to the minimum amount the debtor must pay in order to keep the property, a calculation that fol-
lows a statutory formula. A creditor can move to have the automatic stay lifted for want of ade-
quate protection. The amount of adequate
payment is governed under §1325(a)(5)
and generally cannot be less than the al-
lowable amount of the claim. This provi-
sion is often referred to as the
“cramdown” section. The amount of the
allowable claim is the value of the collat-
eral. So, an under-secured creditor will be
promised payment of the secured portion CASE CONNECTION
of the loan and keeps the lien on the prop-
erty until paid in full or discharged, but the
under-secured portion is stripped off and
rendered unsecured. This is referred to as
lien-stripping. There are three exceptions
to cramdown and lien-stripping. The first In re Carter
is the home mortgage, an exception solidi- 205 B.R. 733 (Bankr. E.D. Pa. 1996)
fied by the Supreme Court decision in No-
belman v. American Savings Bank, 508 U.S.
324 (1993). The other two are found with- Issue: Is a nondebtor spouse’s income
included in the calculation of the disposable
in §1325 and allow the entire debt to re- income of a married debtor who individually
main secured regardless of the valuation of files for Chapter 13 bankruptcy?
collateral. The first exception is for pur-
chase-money security interests in motor
vehicles purchased for personal use that Held: Yes, the spouse’s income must be
were incurred within the 910-day period included in the plan budget for determination
(2.5 years) before filing. The second excep- of disposable income. “Consideration of the
tion is for purchase-money security inter- nondebtor spouse’s income is seen as
ests in “any other thing of value” if in- necessary because a portion of that spouse’s
income is likely to be applied to the basic
curred within the one-year period before needs of the debtor.”



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Chapter 26: Bankruptcy Law 69
filing. The result of the home mort-
gage exception is that the only rem-
edy in Chapter 13 is to continue
making mortgage payments as they
come due while simultaneously
catching up on past due amounts.
Payments to Unsecured
Creditors

Like in Chapter 7, all §507 priority
unsecured creditors are entitled to
payment in full in Chapter 13, and
all general unsecured creditors are
entitled to only pro rata distribu-
tions. Notwithstanding the very lim-
ited protection Chapter 13 affords


general unsecured creditors, there are two methods by which those creditors can move to have the
debtor make larger payments under the restructuring plan.


The first comes from §1325(a)(4)
and (a)(5)(B), and maintains that no
creditor, secured or unsecured, CAREER CONNECTION
should receive less in Chapter 13
than they would in a Chapter 7 case.
The second is found in §1325(b) and
represents the second and more sali-
ent application of the means test in
Chapter 13. This section provides
that all of a debtor’s disposable in- Bankruptcy is very much a niche area of law.
come be allocated to plan payments. Bankruptcy practitioners frequently practice
For the purposes of this means test, exclusively in the bankruptcy and debt collection
disposable income is the debtor’s arenas. As a paralegal, you will have the same
current monthly income less options. Do you focus your skills on one area of
amounts reasonably necessary to be law, limiting your overall job prospects but
spent on the maintenance or sup- maximizing your value in a particular field? Or, do
port of the debtor or his or her de- you generalize your knowledge and skills for
pendents, subject, of course, to cer- broader appeal across legal fields? A similar
tain exclusions and restrictions. The question can be asked within the bankruptcy field.
means test calculation begins the While every paralegal working in bankruptcy
same way it does in Chapter 7, by should be familiar with consumer bankruptcy, few
identifying whether the debtor is be- are adept in business bankruptcies. Knowing the
low or above the median income ins and outs of both can increase your value in the
level for a household of his or her job market.
size in the state where he or she re-
sides. For debtors above the median,
disposable income will not be deter-

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70 Chapter 26: Bankruptcy Law
mined by the reasonably necessary standard of
§1325(b), but by the application of the §707(b)(2) NOTEABLE &
means test. This means that an above-median in-
come debtor’s disposable income is equal to their QUOTABLE
monthly income less the strict monthly expenses
allowed in the Chapter 7 statute. It is important
to note that the disposable income calculation is a “Get big or get out.”
calculation of the minimum a debtor will have to Earl Butz, U.S. Secretary of Agriculture
pay under the repayment plan, not a maximum.

Two further points bear mentioning here. First, Earl Butz, Secretary of Agriculture under the
an additional requirement of Chapter 13 is that Nixon Administration, was responsible for
the repayment plan be proposed in “good faith.” abolishing the federal program that reimbursed
This essentially warns against shady, less than farmers for not cultivating all of their land, a
forthright behavior on the part of the debtor lest program designed to prevent crop oversupply.
his or her plan be denied or the case be dis- His policies, and his mantra “get big or get out,”
missed. Second, repayment plans are modifiable
on motion of an interested party, be that the

debtor, trustee, or a creditor. A debtor’s financial circumstances will often change over the course
of the repayment term. These changes may prompt one of the interested parties to propose a mod-
ification, increasing or decreasing plan payments.


A Comparative Look: Chapter 7 vs. Chapter 13

Consumer bankruptcy is the bread and butter of bankruptcy law, and for that reason, should be
the foundation of a paralegal’s knowledge in the field. Nonbusiness filings made up nearly 97% of
the 794,960 bankruptcy cases commenced in 2016. Of those nonbusiness cases, 475,332, roughly
61%, were commenced in Chapter 7, compared to 294,396, or 38%, commenced in Chapter 13
(Table F-2, U.S. Bankruptcy Courts).


Each operative chapter presents its own advantages and disadvantages to the debtor, and its own
set of considerations when it comes to affectively navigating the nuances of the law as a paralegal.
In both cases the debtor achieves their goal of obtaining a fresh start, albeit in vastly different
ways. In Chapter 7, the debtor receives a comparatively expedient discharge of their debts, but per-
haps at the expense of retaining many of their possessions. In Chapter 13, the debtor is able to
keep significantly more property, but at the expense of not discharging quite as much of their debt,
and with a cost in time. A discharge does not come in Chapter 13 until the approved repayment
plan has been complied with, in full, over the entire repayment period. This is a burden unto itself.
Debtors find themselves facing bankruptcy because of unpredictable life changes; the length of
time under a repayment plan in Chapter 13 that a debtor must traverse without being so affected
by unpredictable economic changes is not insignificant, and often presents an insurmountable ob-
stacle to discharge over the life of the plan.


Of particular importance to debtors with large tax debts, Chapter 13 offers two distinct ad-
vantages. First, the automatic stay is in place over the lifetime of the repayment plan, which means



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Chapter 26: Bankruptcy Law 71
that it holds off IRS collection attempts while the debtor is afforded the opportunity to make peri-
odic payments. Second, the post-petition denial of interest on unsecured claims means that the tax
debt no longer accrues interest as of the filing of the petition. In the end, which chapter a debtor
chooses comes down to eligibility, personal preferences, and type and extent of the debtor’s debts
and assets.

Chapter 12: Restructuring for
the Family Farmer or
Fisherman
In reality, Chapter 12 bankruptcy is a busi-
ness bankruptcy, not a consumer bankrupt-
cy, but the similarities between Chapter 12
and Chapter 13 make it easier to discuss in
the wake of consumer bankruptcies. An
important point as we move through this
brief section, is that Chapter 12 bankrupt-
cies accounted for just 461 of the total
bankruptcy cases commenced in 2016
(Table F-2, U.S. Bankruptcy Courts). That is to say, 0.058% of all bankruptcies. With that back-
drop, we briefly cover Chapter 12.


The agriculture industry is a mainstay of American history, and the family farmer in many ways
represents the traditional “American dream.” It embodies land-ownership, hard work, and the en-
trepreneurial spirit. This country was built on agriculture. It is no surprise, then, that there is an
operative bankruptcy chapter devoted to the
protection of just this type of debtor. Chapter
12 was added to the bankruptcy code with the
KEY TAKEAWAYS 1986 amendments as a response to economic
conditions in the country that were having a
particularly heavy impact on small farms. There

Chapter 12 Bankruptcy at a Glance was a crop surplus, land prices rose, and many
small farmers were carrying too much debt. In-

terest rates hit new highs. As a result, many
 Makes up a very small percentage of small farmers were forced off their land. As
bankruptcy cases (.05%) part of their plan to help protect this aspect of
 Represents an important policy decision the American dream, Congress created Chapter
to provide specialized protection for a 12 of the bankruptcy code. The initially enacted
certain class of debtors version of Chapter 12 was set to expire in 1993,
but various extensions were passed over the
 Operates in much the same way as next 20 years. In 2005, BAPCPA not only elim-
Chapter 13 inated the sunset provision and made the chap-
 Eligibility hinges on the definitions of ter a permanent part of the code, it also includ-
family farmer and family fisherman ed family fishermen to the type of debtor eligi-
ble for relief under the chapter. Chapter 12
bears a striking resemblance to Chapter 13 in


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LAW BLOCK II
72 Chapter 26: Bankruptcy Law
both structure and content. Some key simi-
larities are that both involve debt restruc-
HOT TOPICS turing and call for the debtor to propose a
repayment plan; both extend the automatic
stay to codebtors; the requirements for the
Remember Blockbuster? What about Ko- content of the proposed plan are nearly
dak? Below is a list of notable companies identical; and the debtor retains possession
that have filed for bankruptcy and some of the property over the repayment period.
links you might find interesting. One thing Chapter 12 has that 13 does not
 Blockbuster – review their bank- is its own adequate protection statute,
ruptcy petition here found in §1205, instead of applying the
universal adequate protection statute of
 Kodak – explore their bankruptcy §361. Also, Chapter 12 adopts most of the
petition here
rights of a debtor in possession from
 Enron Chapter 11, which is discussed below. An-

 General Motors other important distinction between Chap-
ters 12 and 13 is that the debtor can claim
 Lehman Brother – this was the big- all the same exemptions as a Chapter 7
gest bankruptcy in U.S. history. debtor. In most other respects, Chapter 12
operates the same way as Chapter 13, so
there is little need to go into too much de-

tail. Ultimately, the most important distinction about Chapter 12 is the eligibility requirements.
Chapter 12, while representing an important bankruptcy policy consideration, is a seldom used op-
erative chapter. It is important to know of its existence and its uniqueness, but to not get mired in
its details. The other forms of business bankruptcy embody a more relevant portion of the bank-
ruptcy code.


Section 26.3: Business Bankruptcy


As previously reviewed, business bankruptcy falls opposite consumer bankruptcy on the dividing
line of the law. That is not to say, however, that a paralegal will encounter the unique aspects on
this side of the line particularly of-
ten. Business bankruptcy cases
made up only 3% of all bankruptcy
cases filed in 2016. It also bears re-
peating that this line is an ambigu-
ous one. In practice, the line blurs.
Many individual, consumer bank-
ruptcy cases involve the dissolu-
tion or restructuring of a small
business; many business bankrupt-
cy cases involve aspects of individ-
ual bankruptcy. Then there is the
line between small and medium
sized businesses and large busi-
nesses. There is no standard within

© 2017 UEducate