Leonidas Ralph Mecham, Director

Administrative Office

of the United States Courts

BASICS

Bankruptcy
Public Information Series

Bankruptcy Judges Division

Administrative Office

of the United States Courts

BASICS

Bankruptcy

JUNE 2000

Revised Second Edition
While the information presented in this pamphlet is accurate as of the date of publication, 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.
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

CONTENTS

Table of
INTRODUCTION • 1

THE PAMPHLET

The Bankruptcy Judges Division’s Public

Information Series pamphlet provides

basic information to debtors, creditors,

court personnel, the media, and the general public on different aspects of the

federal bankruptcy laws. The series is

also designed to provide individuals who

may be considering bankruptcy with a

basic explanation of the different chapters under which a bankruptcy case may

be filed and to answer some of the most

commonly asked questions about the

bankruptcy process.

This pamphlet provides general

information only. While every effort

has been made to ensure that the information contained in it is accurate as of

the date of publication, it is not a full

and authoritative statement of the law

on any particular topic. The information presented in the pamphlet should

not be cited or relied upon as legal

authority and 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.

Most importantly, the pamphlet

should not substitute for the advice of

competent legal counsel or a financial

expert. Neither the Bankruptcy Judges

Division nor the Administrative Office

of the United States Courts can provide legal or financial advice. Such

advice may be obtained from a competent attorney, accountant, or financial adviser.

THE PROCESS

Article I, Section 8, of the United States

Constitution authorizes Congress to

enact “uniform Laws on the subject of

Bankruptcies.” Under this grant of

authority, Congress enacted the “Bankruptcy Code” in 1978. The Code,

which is codified as title 11 of the

United States Code, has been amended

several times since its enactment. It is

the uniform federal law that governs all

bankruptcy cases. 

The procedural aspects of the bankruptcy process are governed by the

Federal Rules of Bankruptcy Procedure

(often called the “Bankruptcy Rules”)

and local rules of bankruptcy. The

Bankruptcy Rules contain a set of official

forms for use in bankruptcy cases. The

Bankruptcy Code and Bankruptcy Rules

(and local rules) set forth the formal legal

A Public Information Series of

the Bankruptcy Judges Division

BASICS

Bankruptcy
2 • INTRODUCTION

procedures for dealing with the debt

problems of individuals and businesses.

There is a bankruptcy court for each

judicial district in the country. Each

state has one or more districts. There

are 90 bankruptcy districts across the

country. The bankruptcy courts generally have their own clerk’s offices.

The court official with decision-making power over federal bankruptcy

cases is the United States bankruptcy

judge, a judicial officer of the United

States district court. The bankruptcy

judge may decide any matter connected

with a bankruptcy case, such as eligibility to file or whether a debtor should

receive a discharge of debts. Much of

the bankruptcy process is administrative, however, and is conducted away

from the courthouse. In cases under

chapter 7, 12, or 13, and sometimes in

chapter 11 cases, this administrative

process is carried out by a trustee who

is appointed to oversee the case.

A debtor’s involvement with the

bankruptcy judge is usually very limited.

A typical chapter 7 debtor will not

appear in court and will not see the

bankruptcy judge unless an objection is

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 proceeding at which a debtor must appear is

the meeting of creditors, which is usually held at the offices of the United States

trustee. This meeting is informally called

a “341 meeting” because section 341 of

the Bankruptcy Code requires that the

debtor attend this meeting so that creditors can question the debtor about debts

and property.

A fundamental goal of the federal

bankruptcy laws enacted by Congress

is to give debtors a financial “fresh

start” from burdensome debts. The

Supreme Court made this point about

the purpose of the bankruptcy law in a

1934 decision:

[I]t gives to the honest but

unfortunate debtor...a new opportunity in life and a clear field

for future effort, unhampered by

the pressure and discouragement

of preexisting debt.

Local Loan v. Hunt, 292 U.S. 234, 244

(1934). This goal is accomplished

through the bankruptcy discharge,

which releases debtors from personal

liability from specific debts and prohibits creditors from ever taking any

action against the debtor to collect

those debts. This pamphlet describes

the Discharge in Bankruptcy in a question and answer format, discussing the

The court official

with decision-making

power over federal

bankruptcy cases

is the United States

bankruptcy judge,

a judicial officer of

the United States

district court.
INTRODUCTION • 3

timing of the discharge, the scope of the

discharge (what debts are discharged

and what debts are not discharged),

objections to discharge, and revocation

of the discharge. It also describes what

a debtor can do if a creditor attempts to

collect a discharged debt after the

bankruptcy case is concluded. 

There are five basic types of bankruptcy cases provided for under the

Bankruptcy Code, each of which is discussed in this pamphlet. The cases are

traditionally given the names of the

chapters that describe them.

Chapter 7, entitled Liquidation, contemplates an orderly, court-supervised

procedure by which a trustee collects

the assets of the debtor’s estate, reduces

them to cash, and makes distributions

to creditors, subject to the debtor’s

right to retain certain exempt property

and the rights of secured creditors.

Because there is usually little or no

nonexempt property in most chapter 7

cases, there may not be an actual liquidation of the debtor’s assets. These

cases are called “no-asset cases.” A

creditor holding an unsecured claim

will get a distribution from the bankruptcy estate only if the case is an asset

case and the creditor files a proof of

claim with the bankruptcy court. In

most chapter 7 cases, the debtor

receives a discharge that releases the

debtor from personal liability for certain dischargeable debts. The debtor

normally receives a discharge just a few

months after the petition is filed.

Chapter 13, entitled Adjustment of

Debts of an Individual With Regular

Income, is designed for an individual

debtor who has a regular source of

income. Chapter 13 is often preferable

to chapter 7 because it enables the

debtor to keep a valuable asset, such as

a house. It is also favored because it

allows the debtor to propose a “plan”

to repay creditors over time—usually

three to five years. At a confirmation

hearing, the court either approves or

disapproves the plan, depending on

whether the plan meets the Bankruptcy

Code’s requirements for confirmation.

Chapter 13 is very different from chapter 7, since the chapter 13 debtor usually remains in possession of the property of the estate and makes payments

to creditors, through the trustee, based

on the debtor’s anticipated income over

the life of the plan. Unlike chapter 7,

the debtor does not receive an immediate discharge of debts. The debtor must

complete the payments required under

the plan before the discharge is

received. The debtor is protected from

lawsuits, garnishments, and other creditor action while the plan is in effect.

The discharge is also considerably

broader (i.e., more debts are eliminated) under chapter 13 than the discharge

under chapter 7.

Chapter 11, entitled Reorganization,

ordinarily is used by commercial enterprises that desire to continue operating

a business and repay creditors concurrently through a court-approved plan of

reorganization. The chapter 11 debtor

has the exclusive right to file a plan of

reorganization for the first 120 days

after the order for relief and must provide creditors with a disclosure statement containing information adequate

to enable creditors to evaluate the plan.

The court ultimately approves (confirms) or disapproves the plan of reorganization. Under the confirmed

plan, the debtor can reduce its debts by

repaying a portion of its obligations and

discharging others. The debtor can also

terminate burdensome contracts and
4 • INTRODUCTION

leases, recover assets, and rescale its

operations in order to return to profitability. Under chapter 11, the debtor

normally goes through a period of consolidation and emerges with a reduced

debt load and a reorganized business.

Chapter 12, entitled Adjustment of

Debts of a Family Farmer with Regular

Annual Income, provides debt relief to

family farmers with regular annual

income. The process under chapter 12

is very similar to that of chapter 13

under which the debtor proposes a plan

to repay debts over a period of time—

no more than three years unless the

court approves a longer period, not

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 parallels 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, taxing districts, municipal utilities, and

school districts.

This pamphlet also contains a description of liquidation proceedings under

the Securities Investor Protection Act.

Although the Bankruptcy Code provides

for a stockbroker liquidation proceeding, 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.

Since being established by Congress in

1970, the Securities Investor Protection

Corporation has protected investors

who deposit stocks and bonds with brokerage firms by ensuring that every customer’s property is protected, up to

$500,000 per customer.

The bankruptcy process is complex

and relies on legal concepts like the

“automatic stay,” “discharge,” “exemptions,” and “substantial abuse.” Therefore, the final chapter of this booklet is a

glossary of Bankruptcy Terminology

which explains, in layman’s terms, most

of the legal concepts that apply in cases

filed under the Bankruptcy Code.
The bankruptcy discharge varies

depending on the type of case a debtor

files: chapter 7, 11, 12, or 13. This

Public Information Series pamphlet

attempts to answer some basic questions about the discharge available to

individual debtors under all four chapters including:

1. What is a discharge in bankruptcy?

2. When does the discharge occur?

3. How does the debtor get a discharge?

4. Are all the debtor’s debts discharged

or only some?

5. Does the debtor have a right to a discharge or can creditors object to the

discharge?

6. Can the debtor receive a second discharge 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?

From an individual

debtor’s standpoint, one

of the primary goals of

filing a bankruptcy case

is to obtain relief from

burdensome debt. Relief

is attained through the

bankruptcy discharge, the

purpose of which is to

provide a “fresh start”

to the honest debtor. 

The Discharge DISCHARGE

in Bankruptcy
6 • THE DISCHARGE IN BANKRUPTCY

WHAT IS A DISCHARGE

IN BANKRUPTCY?

Under the federal bankruptcy statute, a

discharge is a release of the debtor

from personal liability for certain specified types of debts. In other words, the

debtor is no longer required by law to

pay any debts that are discharged. The

discharge operates as a permanent

order directed to the creditors of the

debtor that they refrain from taking

any form of collection action on discharged debts, including legal action

and communications with the debtor,

such as telephone calls, letters, and

personal contacts.

Although a debtor is relieved of personal liability for all debts that are discharged, a valid lien (i.e., a charge upon

specific property to secure payment of a

debt) that has not been avoided (i.e.,

made unenforceable) in the bankruptcy

case will remain after the bankruptcy

case. Therefore, a secured creditor may

enforce the lien to recover the property

secured by the lien.

WHEN DOES THE

DISCHARGE OCCUR?

The timing of the discharge varies,

depending on the chapter under which

the case is filed. In a chapter 7 (liquidation) case, for example, the court usually grants the discharge promptly on

expiration of the time fixed for filing a

complaint objecting to discharge and

the time fixed for filing a motion to dismiss the case for substantial abuse (60

days following the first date set for the

341 meeting). Typically, this occurs

about four months after the date the

debtor files the petition with the clerk

of the bankruptcy court. In chapter 11

(reorganization) cases, the discharge

occurs upon confirmation of a chapter

11 plan. In cases under chapter 12

(adjustment of debts of a family

farmer) and 13 (adjustment of debts of

an individual with regular income), the

court grants the discharge as soon as

practicable after the debtor completes

all payments under the plan. Since a

chapter 12 or chapter 13 plan may provide for payments to be made over

three to five years, the discharge typically occurs about four years after the

date of filing.

HOW DOES THE DEBTOR

GET A DISCHARGE?

Unless there is litigation involving

objections to the discharge, the debtor

will automatically receive a discharge.

The Federal Rules of Bankruptcy

Procedure provide for the clerk of the

bankruptcy court to mail a copy of the

order of discharge to all creditors, the

United States trustee, the trustee in the

case, and the trustee’s attorney, if any.

The debtor and the debtor’s attorney

also receive copies of the discharge

order. The notice, which is simply a

copy of the final order of discharge, is

not specific as to those debts determined by the court to be non-dischargeable, i.e., not covered by the

discharge. The notice informs creditors generally that the debts owed to

them have been discharged and that

they should not attempt any further

collection. They are cautioned in the

notice that continuing collection

efforts could subject them to punishment for contempt. Any inadvertent

failure on the part of the clerk to send

the debtor or any creditor a copy of

the discharge order promptly within

the time required by the rules does not

affect the validity of the order granting the discharge.
THE DISCHARGE IN BANKRUPTCY • 7

Under the federal

bankruptcy statute,

a discharge is a

release of the debtor

from personal liability

for certain specified

types of debts. In

other words, the

debtor is no longer

required by law to

pay any debts that

are discharged.

ARE ALL OF THE DEBTOR’S

DEBTS DISCHARGED OR

ONLY SOME?

Not all debts are discharged. The debts

discharged vary under each chapter of

the Bankruptcy Code. Section 523(a) of

the Code specifically excepts various categories of debts from the discharge

granted to individual debtors. Therefore,

the debtor must still repay those debts

after bankruptcy. Congress has determined that these types of debts are not

dischargeable for public policy reasons

(based either on the nature of the debt or

the fact that the debts were incurred due

to improper behavior of the debtor, such

as the debtor’s drunken driving).

There are 18 categories of debt excepted from discharge under chapters 7, 11,

and 12. A more limited list of exceptions

applies to cases under chapter 13.

Generally speaking, the exceptions to

discharge apply automatically if the language prescribed by section 523(a)

applies. The most common types of

non-dischargeable debts are certain

types of tax claims, debts not set forth

by the debtor on the lists and schedules

the debtor must file with the court,

debts for spousal or child support or

alimony, debts for willful and malicious

injuries to person or property, debts to

governmental units for fines and penalties, debts for most government funded

or guaranteed educational loans or benefit overpayments, debts for personal

injury caused by the debtor’s operation

of a motor vehicle while intoxicated,

and debts for certain condominium or

cooperative housing fees.

The types of debts described in sections 523(a)(2), (4), (6), and (15) (obligations affected by fraud or maliciousness

or certain debts incurred in connection

with property settlements arising out of

a separation agreement or divorce

decree) are not automatically excepted

from discharge. Creditors must ask the

court to determine that these debts are

excepted from discharge. In the absence

of an affirmative request by the creditor

and subsequent granting of the request

by the court, the types of debts set out in

sections 523(a)(2), (4), (6), and (15) will

be discharged.

A broader discharge of debts is available to a debtor in a chapter 13 case than

in a chapter 7 case. As a general rule, the

chapter 13 debtor is discharged from all

debts provided for by the plan except

certain long-term obligations (such as a

home mortgage), debts for alimony or

child support, debts for most govern-
8 • THE DISCHARGE IN BANKRUPTCY

ment funded or guaranteed educational

loans or benefit overpayments, debts

arising from death or personal injury

caused by driving while intoxicated or

under the influence of drugs, and debts

for restitution or a criminal fine included

in a sentence on the debtor’s conviction

of a crime. Although a chapter 13 debtor

generally receives a discharge only after

completing all payments required by the

court-approved (i.e., “confirmed”) repayment plan, there are some limited circumstances under which the debtor may

request the court to grant a “hardship

discharge” even though the debtor has

failed to complete plan payments. Such a

discharge is available only to a debtor

whose failure to complete plan payments is due to circumstances beyond the

debtor’s control.

The scope of a chapter 13 “hardship

discharge” is similar to that in a chapter 7 case with regard to the types of

debts that are excepted from the discharge. A hardship discharge also is

available in chapter 12 if the failure to

complete plan payments is due to “circumstances for which the debtor

should not justly be held accountable.”

DOES THE DEBTOR

HAVE THE RIGHT TO A

DISCHARGE OR CAN

CREDITORS OBJECT TO

THE DISCHARGE?

In chapter 7 cases, the debtor does not

have an absolute right to a discharge.

An objection to the debtor’s discharge

may be filed by a creditor, by the trustee

in the case, or by the United States

trustee. Creditors receive a notice shortly after the case is filed that sets forth

much important information, including

the deadline for objecting to the discharge. A creditor who desires to object

to the debtor’s discharge must do so by

filing a complaint in the bankruptcy

court before the deadline set out in the

notice. Filing of a complaint starts a

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

the Bankruptcy Code, including the

transfer or concealment of property

with intent to hinder, delay, or defraud

creditors; destruction or concealment of

books or records; perjury and other

fraudulent acts; failure to account for

the loss of assets; violation of a court

order; or an earlier discharge in a chapA governmental unit

or private employer

may not discriminate

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 DISCHARGE IN BANKRUPTCY • 9

ter 7 or 11 case commenced within six

years before the date the petition was

filed. If the issue of the debtor’s right to

a discharge goes to trial, the objecting

party has the burden of proving all the

facts essential to the objection.

In chapter 12 and chapter 13 cases,

the debtor is entitled to a discharge

upon completion of all payments under

the plan. The Bankruptcy Code does

not provide grounds for objecting to the

discharge of a chapter 12 or chapter 13

debtor. Creditors can object to confirmation of the repayment plan, but cannot object to the discharge if the debtor

has completed making plan payments.

CAN A DEBTOR RECEIVE A

SECOND DISCHARGE IN A

LATER CHAPTER 7 CASE?

A discharge will be denied in a later

chapter 7 case if the debtor has been

granted a discharge under chapter 7 or

chapter 11 in a case filed within six years

before the second petition is filed. The

debtor will also be denied a chapter 7

discharge if he or she previously was

granted a discharge in a chapter 12 or

chapter 13 case filed within six years

before the date of the filing of the second

case unless (1) all the “allowed unsecured” claims in the earlier case were

paid in full, or (2) payments under the

plan in the earlier case totaled at least 70

percent of the allowed unsecured claims

and the debtor’s plan was proposed in

good faith and the payments represented

the debtor’s best effort.

CAN THE DISCHARGE

BE REVOKED?

A discharge can be revoked under certain

circumstances. For instance, a trustee,

creditor, or the United States trustee may

request that the court revoke the debtor’s

discharge in a chapter 7 case based on

allegations that the debtor obtained the

discharge fraudulently; the debtor failed

to disclose the fact that he or she

acquired or became entitled to acquire

property that would constitute property

of the bankruptcy estate; or the debtor

committed one of several acts of impropriety described in section 727(a)(6) of

the Bankruptcy Code. Typically, a

request to revoke the debtor’s discharge

must be filed within one year after the

granting of the discharge or, in some

cases, before the date that the case is

closed. It is up to the court to determine

whether such allegations are true and, if

so, to revoke the discharge.

In a chapter 13 case, if confirmation

of a plan or the discharge is obtained

through fraud, the court can revoke the

order of confirmation or discharge.

MAY THE DEBTOR PAY A

DISCHARGED DEBT AFTER

THE BANKRUPTCY CASE

HAS BEEN CONCLUDED?

A debtor who has received a discharge

may voluntarily repay any discharged

debt. A debtor may repay a discharged

debt even though it can no longer be

legally enforced. Sometimes a debtor

agrees to repay a debt because it is

owed to a family member or because it

represents an obligation to an individual for whom the debtor’s reputation is

important, such as a family doctor. 

WHAT CAN THE DEBTOR

DO IF A CREDITOR

ATTEMPTS TO COLLECT A

DISCHARGED DEBT AFTER

THE CASE IS CONCLUDED?

If a creditor attempts collection efforts

on a discharged debt, the debtor can

file a motion with the court, reporting
10 • THE DISCHARGE IN BANKRUPTCY

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 violated. The discharge constitutes a permanent 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 discriminate 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; discriminating 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 employment if the discrimination is based solely upon the bankruptcy filing.
ALTERNATIVES TO

CHAPTER 7

Debtors should be aware that there are

several alternatives to chapter 7 relief.

For example, debtors who are engaged

in business, including corporations,

partnerships, and sole proprietorships,

may prefer to remain in business and

avoid liquidation. Such debtors should

consider filing a petition under chapter

11 of the Bankruptcy Code. Under chapter 11, the debtor may seek an adjustment of debts, either by reducing the

debt or by extending the time for repayment, or may seek a more comprehensive reorganization. Sole proprietorships

may also be eligible for relief under

chapter 13 of the Bankruptcy Code.

In addition, individual debtors who

have regular income may seek an adjustment of debts under chapter 13

of the Bankruptcy Code. Indeed, the

court may dismiss a chapter 7 case filed

by an individual whose debts are primarily consumer rather than business

debts if the court finds that the granting

of relief would be a substantial abuse of

the provisions of chapter 7. 11 U.S.C.

§ 707(b). A number of courts have concluded that a chapter 7 case may be dismissed for substantial abuse when the

debtor has the ability to propose and

carry out a workable and meaningful chapter 13 plan.

Debtors should also be aware that

out-of-court agreements with creditors

Liquidation

Under the

Bankruptcy Code

Chapter 7 of the United

States Bankruptcy Code is

the Bankruptcy Code’s 

“liquidation” chapter.

Lawyers sometimes refer

to it as a “straight

bankruptcy.” It is used

primarily by individuals

who wish to free themselves

of debt simply and 

inexpensively, but may

also be used by businesses

that wish to liquidate and

terminate their business.

7

CHAPTE R
12 • LIQUIDATION UNDER THE BANKRUPTCY CODE

or debt counseling services may provide

an alternative to a bankruptcy filing.

BACKGROUND

The potential chapter 7 debtor should

understand that a straight bankruptcy

case does not involve the filing of

a plan of repayment as in chapter 13,

but rather envisions the bankruptcy

trustee’s gathering and sale of the

debtor’s nonexempt assets, from which

holders of claims (creditors) will receive

distributions in accordance with the

provisions of the Bankruptcy Code.

Part of the debtor’s property may be

subject to liens and mortgages that

pledge the property to other creditors.

In addition, under chapter 7, the individual debtor is permitted to retain certain “exempt” property. The debtor’s

remaining assets are liquidated by a

trustee. Accordingly, potential debtors

should realize that the filing of a petition under chapter 7 may result in the

loss of property.

In order to qualify for relief under

chapter 7 of the Bankruptcy Code, the

debtor must be an individual, a partnership, or a corporation. 11 U.S.C.

§§ 109(b); 101(41). Relief is available

under chapter 7 irrespective of the

amount of the debtor’s debts or

whether the debtor is solvent or insolvent. An individual cannot file under

chapter 7 or any other chapter, however, if during the preceding 180 days a

prior bankruptcy petition was dismissed due to the debtor’s willful failure to appear before the court or comply with orders of the court or the

debtor voluntarily dismissed the previous case after creditors sought relief

from the bankruptcy court to recover

property upon which they hold liens.

11 U.S.C. §§ 109(g), 362(d) and (e).

One of the primary purposes of

bankruptcy is to discharge certain debts

to give an honest individual debtor a

“fresh start.” The discharge has the

effect of extinguishing the debtor’s personal liability on dischargeable debts.

In a chapter 7 case, however, a discharge is available to individual debtors

only, not to partnerships or corporations. 11 U.S.C. § 727(a)(1). Although

the filing of an individual chapter 7

petition usually results in a discharge of

debts, an individual’s right to a discharge is not absolute, and some types

of debts are not discharged. Moreover,

a bankruptcy discharge does not extinguish a lien on property.

HOW CHAPTER 7 WORKS

A chapter 7 case begins with the

debtor’s filing a petition with the bankruptcy court.

1 The petition should be

filed with the bankruptcy court serving

the area where the individual lives or

where the business debtor has its principal place of business or principal

assets. 28 U.S.C. § 1408. In addition to

the petition, the debtor is also required

to file with the court several schedules

of assets and liabilities, a schedule of

current income and expenditures, a

statement of financial affairs, and a

schedule of executory contracts and

unexpired leases. Bankruptcy Rule

1007(b). A husband and wife may file a

joint petition or individual petitions.

11 U.S.C. § 302(a). (Official Bankruptcy Forms can be purchased at a

legal stationery store. They are not

available from the court.)

In order to complete the Official

Bankruptcy Forms which make up the

petition and schedules, the debtor(s)

will need to compile the following

information:
LIQUIDATION UNDER THE BANKRUPTCY CODE • 13

1. A list of all creditors and the amount

and nature of their claims;

2. The source, amount, and frequency

of the debtor’s income;

3. A list of all of the debtor’s property;

and

4. A detailed list of the debtor’s monthly living expenses, i.e., food, clothing,

shelter, utilities, taxes, transportation,

medicine, etc.

Currently, the courts are required to

charge a $155 case filing fee, a $30 miscellaneous administrative fee, and a

$15 trustee surcharge (a total of $200).

The fees should be paid to the clerk of

the court upon filing or may, with the

court’s permission, be paid by individual debtors in installments. 28 U.S.C.

§ 1930(a); Bankruptcy Rule 1006(b);

Bankruptcy Court Miscellaneous Fee

Schedule, Item 8. Rule 1006(b) limits

to four the number of installments for

the filing fee. The final installment shall

be payable not later than 120 days after

filing the petition. For cause shown, the

court may extend the time of any

installment, provided that the last

installment is paid not later than 180

days after the filing of the petition.

Bankruptcy Rule 1006(b). The $30

administrative fee and the $15 trustee

surcharge may be paid in installments

in the same manner as the filing fee. If

a joint petition is filed, only one filing

fee, one administrative fee, and one

trustee surcharge are charged. Debtors

should be aware that failure to pay

these fees may result in dismissal of the

case. 11 U.S.C. § 707(a).

The filing of a petition under chapter

7 “automatically stays” most actions

against the debtor or the debtor’s property. 11 U.S.C. § 362. This stay arises

by operation of law and requires no

judicial action. As long as the stay is in

effect, creditors generally cannot initiate or continue any lawsuits, wage garnishments, or even telephone calls

demanding payments. Creditors normally receive notice of the filing of the

petition from the clerk.

One of the schedules that will be

filed by the individual debtor is a

schedule of “exempt” property. Federal

bankruptcy law provides that an individual debtor

2 can protect some property from the claims of creditors either

because it is exempt under federal

bankruptcy law or because it is exempt

under the laws of the debtor’s home

state. 11 U.S.C. § 522(b). Many states

have taken advantage of a provision in

the bankruptcy law that permits each

state to adopt its own exemption law

in place of the federal exemptions. In

other jurisdictions, the individual

debtor has the option of choosing

between a federal package of exemptions or exemptions available under

state law. Thus, whether certain property is exempt and may be kept by the

debtor is often a question of state law.

Legal counsel should be consulted to

determine the law of the state in which

the debtor lives.

A “meeting of creditors” is usually

held 20 to 40 days after the petition is

filed. If the United States trustee or

bankruptcy administrator

3 designates

a place for the meeting that is not regularly staffed by the United States

trustee or bankruptcy administrator,

the meeting may be held no more than

60 days after the order for relief.

Bankruptcy Rule 2003(a). The debtor

must attend this meeting, at which
14 • LIQUIDATION UNDER THE BANKRUPTCY CODE

creditors may appear and ask questions

regarding the debtor’s financial affairs

and property. 11 U.S.C. § 343. If a husband and wife have filed a joint petition, they both must attend the creditors’ meeting. The trustee also will

attend this meeting. It is important for

the debtor to cooperate with the trustee

and to provide any financial records or

documents that the trustee requests.

The trustee is required to examine the

debtor orally at the meeting of creditors

to ensure that the debtor is aware of the

potential consequences of seeking a discharge in bankruptcy, including the

effect on credit history, the ability to

file a petition under a different chapter,

the effect of receiving a discharge, and

the effect of reaffirming a debt. In some

courts, trustees may provide written

information on these topics at or in

advance of the meeting, to ensure that

the debtor is aware of this information.

In order to preserve their independent

judgment, bankruptcy judges are prohibited from attending the meeting of

creditors. 11 U.S.C. § 341(c).

In order to accord the debtor complete relief, the Bankruptcy Code allows

the debtor to convert a chapter 7 case to

either a chapter 11 reorganization case

or a case under chapter 13,

4 as long as

the debtor meets the eligibility standards

under the chapter to which the debtor

seeks to convert, and the case has not

previously been converted to chapter 7

from either chapter 11 or chapter 13.

Thus, the debtor will not be permitted to

convert the case repeatedly from one

chapter to another. 11 U.S.C. § 706(a).

ROLE OF THE CASE

TRUSTEE

Upon the filing of the chapter 7 petition,

an impartial case trustee is appointed by

the United States trustee (or by the court

in Alabama and North Carolina) to

administer the case and liquidate the

debtor’s nonexempt assets. 11 U.S.C.

§§ 701, 704. If, as is often the case, all

of the debtor’s assets are exempt or subject to valid liens, there will be no distribution to unsecured creditors. Typically,

most chapter 7 cases involving individual debtors are “no asset” cases. If the

case appears to be an “asset” case at the

outset, however, unsecured creditors

5

who have claims against the debtor must

file their claims with the clerk of court

within 90 days after the first date set for

the meeting of creditors. Bankruptcy

Rule 3002(c). In the typical no asset

chapter 7 case, there is no need for creditors to file proofs of claim. If the trustee

later recovers assets for distribution to

unsecured creditors, creditors will be

given notice of that fact and additional

time to file proofs of claim. Although

secured creditors are not required to file

proofs of claim in chapter 7 cases in

order to preserve their security interests

or liens, there may be circumstances

when it is desirable to do so. A creditor

in a chapter 7 case who has a lien on the

debtor’s property should consult an

attorney for advice.

The commencement of a bankruptcy

case creates an “estate.” The estate

technically becomes the temporary legal

owner of all of the debtor’s property.

The estate consists of all legal or equitable interests of the debtor in property

as of the commencement of the case,

including property owned or held by

another person if the debtor has an

interest in the property. Generally

speaking, the debtor’s creditors are paid

from nonexempt property of the estate.

The primary role of a chapter 7

trustee in an “asset” case is to liquidate
LIQUIDATION UNDER THE BANKRUPTCY CODE • 15

Upon the filing of

the chapter 7

petition, an impartial

case trustee is

appointed by the

United States trustee

(or by the court

in Alabama and

North Carolina)

to administer the

case and liquidate

the debtor’s

nonexempt assets.

the debtor’s nonexempt assets in a

manner that maximizes the return to

the debtor’s unsecured creditors. To

accomplish this, the trustee attempts to

liquidate the debtor’s nonexempt property, i.e., property that the debtor owns

free and clear of liens and the debtor’s

property which has market value above

the amount of any security interest or

lien and any exemption that the debtor

holds in the property. The trustee also

pursues causes of action (lawsuits)

belonging to the debtor and pursues the

trustee’s own causes of action to recover money or property under the

trustee’s “avoiding powers.” The

trustee’s avoiding powers include the

power to set aside preferential transfers

made to creditors within 90 days before

the petition, the power to undo security interests and other prepetition transfers of property that were not properly

perfected under nonbankruptcy law at

the time of the petition, and the power

to pursue nonbankruptcy claims such

as fraudulent conveyance and bulk

transfer remedies available under state

law. In addition, if the debtor is a business, the bankruptcy court may authorize the trustee to operate the debtor’s

business for a limited period of time, if

such operation will benefit the creditors

of the estate and enhance the liquidation of the estate. 11 U.S.C. § 721.

The distribution of the property of

the estate is governed by section 726 of

the Bankruptcy Code, which sets forth

the order of payment of all claims.

Under section 726, there are six classes

of claims, and each class must be paid

in full before the next lower class is

paid anything. The debtor is not particularly interested in the trustee’s disposition of the estate assets, except with

respect to the payment of those debts

which for some reason are not dischargeable in the bankruptcy case. The

debtor’s major interests in a chapter 7

case are in retaining exempt property

and in getting a discharge that covers as

many debts as possible.

DISCHARGE

A discharge releases the debtor from personal liability for discharged debts and

prevents the creditors owed those debts

from taking any action against the

debtor or his property to collect the

debts. The bankruptcy law regarding the

scope of a chapter 7 discharge is com-
16 • LIQUIDATION UNDER THE BANKRUPTCY CODE

plex, and debtors should consult competent legal counsel in this regard prior to

filing. As a general rule, however,

excluding cases which are dismissed or

converted, individual debtors receive a

discharge in more than 99 percent of

chapter 7 cases. In most cases, unless a

complaint has been filed objecting to the

discharge or the debtor has filed a written waiver, the discharge will be granted

to a chapter 7 debtor relatively early in

the case, that is, 60 to 90 days after the

date first set for the meeting of creditors.

Bankruptcy Rule 4004(c).

The grounds for denying an individual debtor a discharge in a chapter 7

case are very narrow and are construed

against a creditor or trustee seeking to

deny the debtor a chapter 7 discharge.

Among the grounds for denying a discharge to a chapter 7 debtor are that the

debtor failed to keep or produce adequate books or financial records; the

debtor failed to explain satisfactorily

any loss of assets; the debtor committed

a bankruptcy crime such as perjury; the

debtor failed to obey a lawful order of

the bankruptcy court; or the debtor

fraudulently transferred, concealed, or

destroyed property that would have

become property of the estate. 11 U.S.C.

§ 727; Bankruptcy Rule 4005.

In certain jurisdictions, secured creditors may retain some rights to seize

pledged property, even after a discharge

is granted. Depending on individual circumstances, a debtor wishing to keep

possession of the pledged property,

such as an automobile, may find it

advantageous to “reaffirm” the debt. A

reaffirmation is an agreement between

the debtor and the creditor that the

debtor will pay all or a portion of the

money owed, even though the debtor

has filed bankruptcy. In return, the

creditor promises that, as long as payments are made, the creditor will not

repossess or take back the automobile

or other property. Because there is a

disagreement among the courts concerning whether a debtor whose debt is

not in default may retain the property

and pay under the original contract

terms without reaffirming the debt,

legal counsel should be consulted to

ensure that the debtor’s rights are protected and that any reaffirmation is in

the debtor’s best interest.

If the debtor elects to reaffirm the

debt, the reaffirmation should be accomplished prior to the granting of a discharge. A written agreement to reaffirm

a debt must be filed with the court and,

if the debtor is not represented by an

attorney, must be approved by the judge.

11 U.S.C. § 524(c). The Bankruptcy

Code requires that reaffirmation agreements contain an explicit statement

advising the debtor that the agreement is

not required by bankruptcy or nonbankruptcy law. In addition, the debtor’s

attorney is required to advise the debtor

of the legal effect and consequences of

such an agreement, including a default

under such an agreement. The Code

requires a reaffirmation hearing only if

the debtor has not been represented by

an attorney during the negotiating of the

agreement. 11 U.S.C. § 524(d). The

debtor may repay any debt voluntarily,

however, whether or not a reaffirmation

agreement exists. 11 U.S.C. § 524(f).

Most claims against an individual

chapter 7 debtor are discharged. A creditor whose unsecured claim is discharged

may no longer initiate or continue any

legal or other action against the debtor

to collect the obligation. A discharge

under chapter 7, however, does not discharge an individual debtor from certain
LIQUIDATION UNDER THE BANKRUPTCY CODE • 17

specific types of debts listed in section

523 of the Bankruptcy Code. Among the

types of debts which are not discharged

in a chapter 7 case are alimony and child

maintenance and support obligations,

certain taxes, debts for certain educational benefit overpayments or loans

made or guaranteed by a governmental

unit, debts for willful and malicious

injury by the debtor to another entity or

to the property of another entity, debts

for death or personal injury caused by

the debtor’s operation of a motor vehicle

while the debtor was intoxicated from

alcohol or other substances, and debts

for criminal restitution orders under title

18, United States Code. 11 U.S.C.

§ 523(a). To the extent that these types

of debts are not fully paid in the chapter

7 case, the debtor is still responsible for

them after the bankruptcy case has concluded. Debts for money or property

obtained by false pretenses, debts for

fraud or defalcation while acting in a

fiduciary capacity, debts for willful and

malicious injury by the debtor to another entity or to the property of another

entity, and debts arising from a property

settlement agreement incurred during or

in connection with a divorce or separation are discharged unless a creditor

timely files and prevails in an action to

have such debts declared excepted from

the discharge. 11 U.S.C. § 523(c);

Bankruptcy Rule 4007(c).

The court may revoke a chapter 7

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 fraudulently failed to report the acquisition of

such property or to surrender the property to the trustee. 11 U.S.C. § 727(d).

NOTES

1. An involuntary chapter 7 case may

be commenced under certain circumstances by the filing of a petition by

creditors holding claims against the

debtor. 11 U.S.C. § 303.

2. Each debtor in a joint case (both husband and wife) can claim exemptions

under the federal bankruptcy laws. 11

U.S.C. § 522(m).

3. United States trustees and bankruptcy

administrators are responsible for establishing a panel of private trustees to

serve as trustees in chapter 7 cases and

for supervising the administration of

cases and trustees in cases under chapters 7, 11, 12, and 13 of the Bankruptcy

Code. Bankruptcy administrators serve

in the judicial districts in the states of

Alabama and North Carolina.

4. A fee of $400 is charged for converting, on request of the debtor, a case

under chapter 7 to a case under chapter

11. There is no fee for converting from

chapter 7 to chapter 13.

5. Unsecured debts generally may be

defined as those for which the extension

of credit was based purely upon an evaluation by the creditor of the debtor’s

ability to pay, as opposed to secured

debts, for which the extension of credit

was based upon the creditor’s right to

seize pledged property on default, in

addition to the debtor’s ability to pay.
BACKGROUND

Chapter 13 is designed for individuals

with regular income who desire to pay

their debts but are currently unable to

do so. The purpose of chapter 13 is to

enable financially distressed individual

debtors, under court supervision and

protection, to propose and carry out a

repayment plan under which creditors

are paid over an extended period of

time. Under this chapter, debtors are

permitted to repay creditors, in full or

in part, in installments over a threeyear period, during which time creditors are prohibited from starting or

continuing collection efforts. A plan

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 business, 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 chapter 13 or any other chapter if, during

the preceding 180 days, a prior bankruptcy petition was dismissed due to

the debtor’s willful failure to appear

before the court or comply with orders

Chapter 13 of the

United States Bankruptcy

Code is frequently referred

to as a “wage earner”

chapter, although it is

available to individuals

with regular income

from any source, not

just wages.

13

CHAPTE R

Individual Debt

Adjustment
INDIVIDUAL DEBT ADJUSTMENT • 19

of the court or was voluntarily dismissed after creditors sought relief

from the bankruptcy court to recover

property upon which they hold liens.

11 U.S.C. §§ 109(g), 362(d) and (e).

HOW CHAPTER 13 WORKS

A chapter 13 case begins with the filing

of a petition with the bankruptcy court

serving the area where the debtor has a

domicile or residence. Unless the court

orders otherwise, the debtor also shall

file with the court (1) schedules of

assets and liabilities, (2) a schedule of

current income and expenditures, (3) a

schedule of executory contracts and

unexpired leases, and (4) a statement of

financial affairs. Bankruptcy Rule

1007(b). A husband and wife may file a

joint petition or individual petitions.

11 U.S.C. § 302(a). (Official Bankruptcy Forms can be purchased at a

legal stationery store. They are not

available from the court.)

Currently, the courts are required to

charge a $155 case filing fee and a $30

miscellaneous administrative fee. The

fees should be paid to the clerk of the

court upon filing or may, with the

court’s permission, be paid in installments. 28 U.S.C. § 1930(a); Bankruptcy Rule 1006(b); Bankruptcy Court

Miscellaneous Fee Schedule, Item 8.

Rule 1006(b) limits to four the number

of installments for the filing fee. The

final installment shall be payable not

later than 120 days after filing the petition. For cause shown, the court may

extend the time of any installment,

provided that the last installment is

paid not later than 180 days after the

filing of the petition. Bankruptcy Rule

1006(b). If a joint petition is filed, only

one filing fee and one administrative

fee are charged.

In order to complete the Official

Bankruptcy Forms which make up the

petition, statement of financial affairs,

and schedules, the debtor will need to

compile the following information:

1. A list of all creditors and the

amounts and nature of their claims;

2. The source, amount, and frequency

of the debtor’s income;

3. A list of all of the debtor’s property;

and

4. A detailed list of the debtor’s monthly living expenses, i.e., food, clothing,

shelter, utilities, taxes, transportation,

medicine, etc.

When a husband and wife file a joint

petition or each spouse files an individual petition, the above detailed data

must be gathered for both spouses. So

that financial responsibilities can be

accurately assessed when only one

spouse files, the income and expenses

of the non-filing spouse should be

included in the debtor’s schedules and

statement of financial affairs.

Upon the filing of the petition, an

impartial trustee is appointed to administer the case. 11 U.S.C. § 1302. If the

number of cases so warrants, the

United States trustee may appoint a

standing trustee to serve in all chapter

13 cases in a district. 28 U.S.C.

§ 586(b). A primary role of the chapter

13 trustee is to serve as a disbursing

agent, collecting payments from

debtors and making distributions to

creditors. 11 U.S.C. § 1302.

The filing of the petition under chapter 13 “automatically stays” most collection actions against the debtor or
20 • INDIVIDUAL DEBT ADJUSTMENT

the debtor’s property. 11 U.S.C. § 362.

As long as the “stay” is in effect, creditors generally cannot initiate or continue any lawsuits, wage garnishment,

or even telephone calls demanding

payments. Creditors receive notice of

the filing of the petition from the clerk

or the trustee. Further, chapter 13 contains a special automatic stay provision

applicable to creditors. Specifically,

after the commencement of a chapter

13 case, unless the bankruptcy court

authorizes otherwise, a creditor may

not seek to collect a “consumer debt”

from any individual who is liable with

the debtor. 11 U.S.C. § 1301. Consumer debts are those incurred for consumer, as opposed to business, needs.

By virtue of the automatic stay, an

individual debtor faced with a threatened foreclosure of the mortgage on his

or her principal residence can prevent

an immediate foreclosure by filing a

chapter 13 petition. Chapter 13 then

affords the debtor a right to cure

defaults on long-term home mortgage

debts by bringing the payments current

over a reasonable period of time. The

debtor is permitted to cure a default

with respect to a lien on the debtor’s

principal residence up until the completion of a foreclosure sale under state

law. 11 U.S.C. § 1322(c).

The debtor must file a plan of repayment with the petition or within fifteen

days thereafter, unless extended by the

court for cause. Bankruptcy Rule 3015.

The chapter 13 plan must provide for

the full payment of all claims entitled to

priority under section 507

1 (unless the

holder of a particular claim agrees to

different treatment of the claim); if the

plan classifies claims, provide the same

treatment for each claim within each

class; and provide for the submission of

such portion of the debtor’s future

income to the supervision of the trustee

as is necessary for the execution of the

plan. 11 U.S.C. § 1322. Other plan

provisions are permissive. Id. Plans,

which must be approved by the court,

provide for payments of fixed amounts

to the trustee on a regular basis, typically biweekly or monthly. The trustee

then distributes the funds to creditors

according to the terms of the plan,

which may offer creditors less than full

payment on their claims. If the trustee

or a creditor with an unsecured claim2

objects to confirmation of the plan, the

debtor is obligated to pay the amount

of the claim or commit to the proposed

plan all projected “disposable income”

during the period in which the plan is

in effect. 11 U.S.C. § 1325(b). Disposable income is defined as income not

reasonably necessary for the maintenance or support of the debtor or

dependents. If the debtor operates a

business, disposable income is defined

as excluding those amounts which

are necessary for the payment of ordinary operating expenses. 11 U.S.C.

§ 1325(b)(2)(A) and (B).

A meeting of creditors is held in

every case, during which the debtor is

examined under oath. It is usually held

20 to 50 days after the petition is filed.

If the United States trustee or bankruptcy administrator

3 designates a

place for the meeting which is not regularly staffed by the United States

trustee or bankruptcy administrator,

the meeting may be held no more than

60 days after the order for relief.

Bankruptcy Rule 2003(a). The debtor

must attend the meeting, at which creditors may appear and ask questions

regarding the debtor’s financial affairs

and the proposed terms of the plan.
INDIVIDUAL DEBT ADJUSTMENT • 21

11 U.S.C. § 343. If a husband and wife

have filed a joint petition, they both

must attend the creditors’ meeting. The

trustee will also attend the meeting and

question the debtor on the same matters. In order to preserve their independent judgment, bankruptcy judges are

prohibited from attending. 11 U.S.C.

§ 341(c). If there are problems with the

plan, they are typically resolved during

or shortly after the creditors’ meeting.

Generally, problems may be avoided if

the petition and plan are complete and

accurate and the trustee has been consulted prior to the meeting.

In a chapter 13 case, unsecured creditors who have claims against the

debtor must file their claims with the

court within 90 days after the first date

set for the meeting of creditors.

Bankruptcy Rule 3002(c). A governmental unit, however, may file a proof

of claim until the expiration of 180

days from the date the case is filed.

11 U.S.C. § 502(b)(9).

After the meeting of creditors is concluded, the bankruptcy judge must

determine at a confirmation hearing

whether the plan is feasible and meets

the standards for confirmation set forth

in the Bankruptcy Code. 11 U.S.C.

§§ 1324 and 1325. Creditors, who will

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

offered under the plan are less than

creditors would receive if the debtor’s

assets were liquidated or that the

debtor’s plan does not commit all of the

debtor’s projected disposable income

for the three-year period of the plan.

Within thirty days after the filing of

the plan, even if the plan has not yet

been approved by the court, the debtor

must start making payments to the

trustee. 11 U.S.C. § 1326(a)(1). If the

plan is confirmed by the bankruptcy

judge, the chapter 13 trustee commences

distribution of the funds received in

accordance with the plan “as soon as

practicable.” 11 U.S.C. § 1326(a)(2). If

the plan is not confirmed, the debtor has

a right to file a modified plan. 11 U.S.C.

§ 1323. The debtor also has a right to

convert the case to a liquidation case

under chapter 7. 11 U.S.C. § 1307. If

the plan or modified plan is not confirmed and the case is dismissed, the

court may authorize the trustee to retain

a specified amount for costs, but all

other funds paid to the trustee are

returned to the debtor. 11 U.S.C.

§ 1326(a)(2).

On occasion, changed circumstances

will affect a debtor’s ability to make

plan payments, a creditor may object

or threaten to object to a plan, or a

debtor may inadvertently have failed

If the number of

cases so warrants,

the United States

trustee may appoint

a standing trustee

to serve in all

chapter 13 cases

in a district.
22 • INDIVIDUAL DEBT ADJUSTMENT

to list all creditors. In such instances,

the plan may be modified either before

or after confirmation. 11 U.S.C.

§§ 1323 & 1329. Modification after

confirmation is not limited to an initiative by the debtor, but may be at the

request of the trustee or an unsecured

creditor. 11 U.S.C. § 1329(a).

MAKING THE PLAN WORK

The provisions of a confirmed plan are

binding on the debtor and each creditor. 11 U.S.C. § 1327. Once the court

confirms the plan, it is the responsibility of the debtor to make the plan succeed. The debtor must make regular

payments to the trustee, which will

require adjustment to living on a fixed

budget for a prolonged period. Alternatively, the debtor’s employer can

withhold the amount of the payment

from the debtor’s paycheck and transmit it to the chapter 13 trustee.

Furthermore, while confirmation of the

plan entitles the debtor to retain property as long as payments are made, the

debtor may not incur any significant

new credit obligations without consulting the trustee, as such credit obligations may have an impact upon the

execution of the plan. 11 U.S.C.

§§ 1305(c), 1322(a)(1) & 1327.

A debtor may consent to the deduction of the plan payments from the

debtor’s paycheck. Experience has

shown that this practice increases the

likelihood that payments will be made

on time and that the plan will be completed. In any event, failure to make the

payments in accordance with the confirmed plan may result in dismissal of

the case or its conversion to a liquidation case under chapter 7 of the

Bankruptcy Code. 11 U.S.C. § 1307(c).

THE CHAPTER 13

DISCHARGE

The bankruptcy law regarding the

scope of the chapter 13 discharge is

complex and has recently undergone

major changes. Therefore, debtors

should consult competent legal counsel

prior to filing regarding the scope of

the chapter 13 discharge.

The chapter 13 debtor is entitled to a

discharge upon successful completion

of all payments under the chapter 13

plan. 11 U.S.C. § 1328(a). The discharge has the effect of releasing the

debtor from all debts provided for by

Once the court

confirms the plan,

it is the responsibility

of the debtor to

make the plan

succeed. The debtor

must make regular

payments to the

trustee, which will

require adjustment

to living on a fixed

budget for a

prolonged period.
INDIVIDUAL DEBT ADJUSTMENT • 23

the plan or disallowed (under section

502), with limited exceptions. Those

creditors who were provided for in full

or in part under the chapter 13 plan

may no longer initiate or continue any

legal or other action against the debtor

to collect the discharged obligations.

In return for the willingness of the

chapter 13 debtor to undergo the discipline of a repayment plan for three to

five years, a broader discharge is available under chapter 13 than in a chapter

7 case. As a general rule, the debtor is

discharged from all debts provided for

by the plan or disallowed, except certain long term obligations (such as a

home mortgage), debts for alimony or

child support, debts for most government funded or guaranteed educational

loans or benefit overpayments, debts

arising from death or personal injury

caused by driving while intoxicated or

under the influence of drugs, and debts

for restitution or a criminal fine included in a sentence on the debtor’s conviction of a crime. 11 U.S.C. § 1328(a). To

the extent that these types of debts are

not fully paid pursuant to the chapter

13 plan, the debtor will still be responsible for these debts after the bankruptcy case has concluded.

THE CHAPTER 13

HARDSHIP DISCHARGE

After confirmation of a plan, there are

limited circumstances under which the

debtor may request the court to grant a

“hardship discharge” even though the

debtor has failed to complete plan payments. 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

creditors have received at least as much

as they would have received in a chapter 7 liquidation case and when modification of the plan is not possible. Injury

or illness that precludes employment

sufficient to fund even a modified plan

may serve as the basis for a hardship

discharge. The hardship discharge is

more limited than the discharge

described above and does not apply to

any debts that are nondischargeable in

a chapter 7 case. 11 U.S.C. § 523.

NOTES

1. Section 507 sets forth nine categories of unsecured claims which

Congress has, for public policy reasons,

given priority of distribution over other

unsecured claims.

2. Unsecured debts generally may be

defined as those for which the extension of credit was based purely upon an

evaluation by the creditor of the

debtor’s ability to pay. In contrast,

secured debts are those for which the

extension of credit was based upon not

only the creditor’s evaluation of the

debtor’s ability to pay, but upon the

creditor’s right to seize pledged property on default.

3. Bankruptcy Administrators, rather

than U.S. trustees, serve in the judicial

districts in the states of Alabama and

North Carolina.
HOW CHAPTER 11 WORKS

A bankruptcy case commences when a

bankruptcy petition is filed with the

bankruptcy court. Fed. R. Bankr. P.

1002. A petition may be a voluntary

petition, which is filed by the debtor, or

it may be an involuntary petition, which

is filed by creditors that meet certain

requirements. 11 U.S.C. §§ 301, 303.

A voluntary petition should adhere to

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 www.uscourts.gov/

bankform/. The voluntary petition will

include standard information concerning 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 intention 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 considered a small business under 11 U.S.C.

§ 1121(e).

Upon the filing of a voluntary petition for relief under chapter 11 or, in

an involuntary case, the entry of an

order for such relief, the debtor automatically assumes an additional idenA case filed under

chapter 11 of the

United States Bankruptcy

Code is frequently referred

to as a “reorganization”

bankruptcy.

11

CHAPTE R

Reorganization

Under the

Bankruptcy Code
REORGANIZATION UNDER THE BANKRUPTCY CODE • 25

tity as the “debtor in possession.”

11 U.S.C. § 1101. The term refers to

a debtor that keeps possession and

control of its assets while undergoing

a reorganization under chapter 11,

without the appointment of a case

trustee. A debtor will remain a debtor

in possession until the debtor’s plan of

reorganization is confirmed, the

debtor’s case is dismissed or converted

to chapter 7, or a chapter 11 trustee is

appointed. The appointment or election of a trustee occurs only in a small

number of cases. Generally, the

debtor, as “debtor in possession,”

operates the business and performs

many of the functions that a trustee

performs in cases under other chapters. 11 U.S.C. § 1107(a).

A written disclosure statement and a

plan of reorganization must be filed

with the court. 11 U.S.C. § 1121. The

disclosure statement is a document

that must contain information concerning the assets, liabilities, and business affairs of the debtor sufficient to

enable a creditor to make an informed

judgment about the debtor’s plan of

reorganization. 11 U.S.C. § 1125. The

information required is governed by

judicial discretion and the circumstances of the case. The contents of the

plan must include a classification of

claims and must specify how each class

of claims will be treated under the

plan. 11 U.S.C. § 1123. Creditors

whose claims are “impaired,” i.e.,

those whose contractual rights are to

be modified or who will be paid less

than the full value of their claims

under the plan vote on the plan by ballot. 11 U.S.C. § 1126. After the disclosure statement is approved and the ballots are collected and tallied, the bankruptcy court will conduct a confirmation hearing to determine whether to

confirm the plan. 11 U.S.C. § 1128.

THE CHAPTER 11 DEBTOR

IN POSSESSION

While individuals are not precluded

from using chapter 11, it is more typically used to reorganize a business,

which may be a corporation, sole proprietorship, or partnership. A corporation exists separate and apart from its

owners, the stockholders. The chapter

11 bankruptcy case of a corporation

(corporation as debtor) does not put the

personal assets of the stockholders at

risk other than the value of their investment in the company’s stock. A sole

proprietorship (owner as debtor), on

the other hand, does not have an identity separate and distinct from its

owner(s); accordingly, a bankruptcy

case involving a sole proprietorship

includes both the business and personal

assets of the owners-debtors. Like a corporation, a partnership exists separate

and apart from its partners. In a partnership bankruptcy case (partnership as

debtor), however, the partners’ personal

assets may, in some cases, be used to

pay creditors in the bankruptcy case or

the partners may, themselves, be forced

to file for bankruptcy protection.

Section 1107 of the Code places the

debtor in possession in the position of a

fiduciary, with the rights and powers of

a chapter 11 trustee, and requires the

performance of all but the investigative

functions and duties of a trustee. These

duties are set forth in the Bankruptcy

Code and Federal Rules of Bankruptcy

Procedure. 11 U.S.C. §§ 1106, 1107;

Fed. R. Bankr. P. 2015(a). Such powers

and duties include accounting for property, examining and objecting to claims,

and filing informational reports as
26 • REORGANIZATION UNDER THE BANKRUPTCY CODE

required by the court and the United

States trustee, such as monthly operating reports. The debtor in possession

also has many of the other powers and

duties of a trustee including the right,

with the court’s approval, to employ

attorneys, accountants, appraisers, auctioneers, or other professional persons

to assist the debtor during its bankruptcy case. Other responsibilities

include filing tax returns and filing such

reports as are necessary or as the court

orders after confirmation, such as a

final accounting. The United States

trustee is responsible for monitoring

the compliance of the debtor in possession with the reporting requirements.

It should be noted that railroad reorganizations have specific requirements

under subsection IV of chapter 11

which will not be addressed here and

that stock and commodity brokers are

prohibited from filing under chapter 11

and are restricted to chapter 7.

11 U.S.C. § 109(d).

THE SMALL BUSINESS

DEBTOR

A small business debtor is defined by

the Bankruptcy Code as a person

engaged in commercial or business

activities (not including a person that

primarily owns or operates real property) that has aggregate noncontingent

liquidated secured and unsecured debts

that do not exceed $2,000,000.

11 U.S.C. § 101(51C). If a debtor qualifies and elects to be considered a small

business under 11 U.S.C. § 1121(e), the

case is put on a “fast track” and treated differently than a regular chapter 11

case under the Code. For example, the

appointment of a creditors’ committee

and a separate hearing to approve the

disclosure statement are not mandatory

in a small business case. 11 U.S.C.

§ 1102(a)(3). A small business case

proceeds faster than a regular chapter

11 case because the court may conditionally approve a disclosure statement,

subject to final approval after notice

and a hearing and solicitation of votes

for acceptance or rejection of the plan.

Thereafter, the disclosure statement

hearing may be combined with the confirmation hearing. 11 U.S.C. § 1125(f).

In addition, the debtor has a shortened

period of time (100 days from the date

of the order for relief) within which

only the debtor may file a plan. After

the 100-day period expires, any party

in interest may file a plan; however, all

plans must be filed within 160 days

from the date of the order for relief.

11 U.S.C. § 1121(e).

THE SINGLE ASSET REAL

ESTATE DEBTOR

Another type of debtor that has special

provisions under the Bankruptcy Code

is a single asset real estate debtor. The

term “single asset real estate” is

defined as “a single property or project, other than residential real property with fewer than four residential

units, which generates substantially all

of the gross income of a debtor and on

which no substantial business is being

conducted by a debtor” other than

operating the real property and which

has aggregate noncontingent liquidated secured debts of no more than

$4,000,000. 11 U.S.C. § 101(51B).

The Bankruptcy Code provides circumstances under which creditors of a

single asset real estate debtor may

obtain relief from the automatic stay

which are not available to creditors in

ordinary bankruptcy cases. 11 U.S.C.

§ 362(d). On request of a creditor with
REORGANIZATION UNDER THE BANKRUPTCY CODE • 27

a claim secured by the single asset real

estate and after notice and a hearing,

the court will grant relief from the

automatic stay to the creditor unless

the debtor files a feasible plan of reorganization or begins making interest

payments to the creditor within 90

days from the date of the order for

relief. The interest payments must

be equal to the current fair market

interest rate on the value of the creditor’s interest in the real estate.

11 U.S.C. § 362(d)(3).

THE AUTOMATIC STAY

The automatic stay provides for a

period of time in which all judgments,

collection activities, foreclosures, and

repossessions of property are suspended and may not be pursued by the

creditors on any debt or claim that

arose before the filing of the bankruptcy petition. As with cases under

other chapters of the Bankruptcy

Code, a stay of creditor actions

against the debtor automatically goes

into effect when the bankruptcy petition is filed. 11 U.S.C. § 362(a). The

filing of a petition, however, does not

operate as a stay for certain types

of actions listed under 11 U.S.C.

§ 362(b). The stay provides a breathing spell for the debtor, during which

negotiations can take place to try to

resolve the difficulties in the debtor’s

financial situation.

Under specific circumstances, the

secured creditor can obtain an order

from the court granting relief from the

automatic stay. For example, when the

debtor has no equity in the property

and that property is not necessary for

an effective reorganization, the secured

creditor can seek an order of the court

lifting the stay to permit the creditor to

foreclose on the property, sell it, and

apply the proceeds to the debt.

11 U.S.C. § 362(d).

It should be noted that, although

creditors are stayed from action

against the debtor unless relief is granted by the court, section 331 of the

Bankruptcy Code permits applications

for fees to be made by certain professionals during the case. Thus, a trustee,

a debtor’s attorney, or any professional

person appointed by the court may

apply to the court at intervals of 120

days for interim compensation and

reimbursement payments. In very large

cases with extensive legal work the

court may permit more frequent applications. Although professional fees

may be paid pursuant to authorization

by the court, the debtor cannot make

payments to professional creditors on

prepetition obligations, i.e., obligations which arose before the filing of

While individuals are

not precluded from

using chapter 11,

it is more typically

used to reorganize a

business, which may

be a corporation,

sole proprietorship,

or partnership.
28 • REORGANIZATION UNDER THE BANKRUPTCY CODE

the bankruptcy petition. The ordinary

expenses of the ongoing business, however, continue to be paid.

CREDITORS’ COMMITTEES

Creditors’ committees can play a

major role in chapter 11 cases. The

United States trustee, a federal employee to be distinguished from a private

case trustee or panel trustee, appoints

the committee, which ordinarily consists of unsecured creditors who hold

the seven largest unsecured claims

against the debtor. 11 U.S.C. § 1102.

The committee may consult with the

debtor in possession on the administration of the case, investigate the conduct

of the debtor and the operation of the

business, and participate in the formulation of a plan. 11 U.S.C. § 1103. A

creditors’ committee may, with the

court’s approval, hire an attorney or

other professionals to assist in the performance of the committee’s duties. A

creditors’ committee can be an important safeguard to the proper management of the business by the debtor in

possession.

WHO CAN FILE A PLAN

There is no specific statutory time limit

set for the filing of a plan; however, the

debtor (unless a “small business”

debtor, as set out above) has a 120-day

period during which it has an exclusive

right to file a plan. 11 U.S.C.

§ 1121(b). The debtor’s exclusive period in which to file a plan may be

extended or reduced by the court. After

the exclusive period has expired, a creditor or the case trustee may file a competing plan. The United States trustee

may not file a plan. 11 U.S.C. § 307.

A chapter 11 case may continue for

many years unless the court, the United

States trustee, the committee, or another party in interest acts to ensure the

case’s timely resolution. The creditors’

right to file a competing plan provides

incentive for the debtor to file a plan

within the exclusive period and acts as

a check on excessive delay in the case.

AVOIDABLE TRANSFERS

The debtor in possession or the trustee,

as the case may be, has what are called

“avoiding” powers. Such powers may

be used to undo a transfer of money or

property made during a certain period

of time prior to the filing of the bankruptcy petition. By avoiding a particular transfer of property, the debtor in

possession can cancel the transaction

and force the return or “disgorgement”

of the payments or property, which

then are available to pay all creditors.

Generally, the power to avoid transfers

is effective against transfers made within 90 days prior to the filing of the petition. However, transfers to insiders (i.e.,

relatives, general partners, and directors or officers of the debtor) made up

to a year prior to filing can be avoided.

11 U.S.C. §§ 101(31), 101(54), 547,

548. In addition, under 11 U.S.C.

§ 544, the trustee is given the authority

to avoid transfers under applicable state

law, which often provides for longer

time periods. Avoiding powers are used,

for example, to prevent unfair prepetition payments to one creditor at the

expense of all other creditors.

CASH COLLATERAL,

ADEQUATE PROTECTION,

AND OPERATING CAPITAL

Although the preparation, confirmation, and implementation of a plan of

reorganization is at the heart of a chapter 11 case, other issues may arise
REORGANIZATION UNDER THE BANKRUPTCY CODE • 29

which must be addressed by the debtor

in possession. The debtor in possession

may use, sell, or lease property of the

estate in the ordinary course of its business, without prior approval, unless

the court orders otherwise. 11 U.S.C.

§ 363(c). If the intended sale or use is

outside the ordinary course of its business, the debtor must obtain permission

from the court. A debtor in possession

may not use “cash collateral,” i.e., collections of accounts subject to security

interests or proceeds from the sale of

pledged inventory or equipment, without the consent of the secured party or

authorization by the court which must

first examine whether the interest of the

secured party is adequately protected.

11 U.S.C. § 363.

When “cash collateral” is used

(spent), the secured creditors are entitled to receive additional protection

under section 363 of the Bankruptcy

Code. Section 363 defines “cash collateral” as cash, negotiable instruments,

documents of title, securities, deposit

accounts, or other cash equivalents,

whenever acquired, in which the estate

and an entity other than the estate have

an interest. It includes the proceeds,

products, offspring, rents, or profits of

property and the fees, charges,

accounts or payments for the use or

occupancy of rooms and other public

facilities in hotels, motels, or other

lodging properties subject to a creditor’s security interest. The debtor in

possession must file a motion requesting an order from the court authorizing

the use of the cash collateral. Pending

consent of the secured creditor or court

authorization for the debtor in possession’s use of cash collateral, the debtor

in possession must segregate and

account for all cash collateral in its possession. 11 U.S.C. § 363(c)(4). A party

with an interest in property being used

by the debtor may request that the

court prohibit or condition this use to

the extent necessary to provide “adequate protection” to the creditor. 

Adequate protection may be required

to protect the value of the creditor’s

interest in the property being used by

the debtor in possession. This is especially important when there is a

decrease in value of the property. The

debtor may make periodic or lump sum

cash payments, or provide an additional or replacement lien that will result in

the creditor’s property interest being

adequately protected. 11 U.S.C. § 361.

When a chapter 11 debtor needs

operating capital, it may be able to

obtain it from a lender by giving the

lender a court-approved “superpriority” over other unsecured creditors or

a lien on property of the estate.

11 U.S.C. § 364.

APPOINTMENT OR

ELECTION OF A CASE

TRUSTEE

Although the appointment of a case

trustee is a rarity in a chapter 11 case,

a party in interest or the United States

trustee can request the appointment of

a case trustee or examiner at any time

prior to confirmation in a chapter 11

case. The court, on motion by a party

in interest or the United States trustee

and after notice and hearing, shall

order the appointment of a case

trustee for cause, including fraud,

dishonesty, incompetence, or gross

mismanagement, or if such an

appointment is in the interest of creditors, any equity security holders, and

other interests of the estate. 11 U.S.C.

§ 1104(a). The trustee is appointed by
30 • REORGANIZATION UNDER THE BANKRUPTCY CODE

the United States trustee, after consultation with parties in interest and subject to the court’s approval. Fed. R.

Bankr. P. 2007.1. Alternatively, a

trustee in a case may be elected if a

party in interest requests the election

of a trustee within 30 days after the

court orders the appointment of a

trustee. In that instance, the United

States trustee convenes a meeting of

creditors for the purpose of electing a

person to serve as trustee in the case.

11 U.S.C. § 1104(b).

The case trustee is responsible for

management of the property of the

estate, operation of the debtor’s business, and, if appropriate, the filing of

a plan of reorganization. Section 1106

of the Code requires the trustee to file

a plan “as soon as practicable” or,

alternatively, to file a report explaining why a plan will not be filed or

to recommend that the case be converted to another chapter or dismissed. 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

or the United States trustee, terminate

the trustee’s appointment and restore

the debtor to possession and management of the property of the estate and

of the operation of the debtor’s business. 11 U.S.C. § 1105.

THE ROLE OF AN

EXAMINER

The appointment of an examiner in a

chapter 11 case is rare. The role of an

examiner is generally more limited

than that of a trustee. The examiner is

authorized to perform the investigatory functions of the trustee and is

required to file a statement of any

investigation conducted. If ordered to

do so by the court, however, an examiner may carry out any other duties of

a trustee that the court orders the

debtor in possession not to perform.

11 U.S.C. § 1106. Each court has the

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

help the parties negotiate, or review

the debtor’s schedules to determine

whether some of the claims are

improperly categorized. Sometimes,

the examiner may be directed to determine if objections to any proofs of

claim should be filed or whether causAlthough the

appointment of a

case trustee is a rarity

in a chapter 11 case,

a party in interest or

the United States

trustee can request

the appointment of

a case trustee or

examiner at any time

prior to confirmation

in a chapter 11 case.
REORGANIZATION UNDER THE BANKRUPTCY CODE • 31

es of action have sufficient merit so

that further legal action should be

taken. An examiner may not serve as a

trustee. 11 U.S.C. § 321.

THE UNITED STATES

TRUSTEE OR BANKRUPTCY

ADMINISTRATOR 

In addition to the case trustee or examiner and the creditors’ committee, the

United States trustee plays a major role

in monitoring the progress of a chapter

11 case and supervising its administration. The United States trustee is

responsible for monitoring the debtor

in possession’s operation of the business, and the submission of operating

reports and fees. Additionally, the U.S.

Trustee monitors applications for compensation and reimbursement by professionals, plans and disclosure statements filed with the court, and creditors’ committees. The United States

trustee conducts a meeting of the creditors, often referred to as the “section

341 meeting,” in a chapter 11 case. 11

U.S.C. § 341. The United States trustee

and creditors may question the debtor

or the debtor’s corporate representative under oath at the section 341

meeting concerning the debtor’s acts,

conduct, property, and the administration of the case.

The United States trustee also imposes certain requirements on the debtor in

possession concerning matters such as

reporting its monthly income and operating expenses, the establishment of

new bank accounts, and the payment of

current employee withholding and

other taxes. By law, the debtor in possession must pay a quarterly fee to the

United States trustee for each quarter of

a year until the case is converted or dismissed. 28 U.S.C. § 1930(a)(6). The

amount of the fee, which may range

from $250 to $10,000, depends upon

the amount of the debtor’s disbursements during each quarter. Should a

debtor in possession fail to comply with

the reporting requirements of the

United States trustee or orders of the

bankruptcy court or fail to take the

appropriate steps to bring the case to

confirmation, the United States trustee

may file a motion with the court to have

the debtor’s chapter 11 case converted

to a case under another chapter of the

Code or to have the case dismissed.

It should be noted that in North

Carolina and Alabama, bankruptcy

administrators perform similar functions that United States trustees perform in the remaining forty-eight

states. The bankruptcy administrator

program is administered by the

Administrative Office of the United

States Courts, while the United States

trustee program is administered by the

Department of Justice. For purposes of

this fact sheet, references to United

States trustees are also applicable to

bankruptcy administrators.

MOTIONS

Prior to confirmation of a plan, there

are several activities that may take

place in a chapter 11 case. The continued operation of the debtor’s business

may lead to the filing of a number of

contested motions. The most common

are those seeking relief from the automatic stay, the use of cash collateral, or

to obtain credit. There may also be litigation over executory (i.e., unfulfilled)

contracts and unexpired leases and the

assumption or rejection of those executory contracts and unexpired leases

by the debtor in possession. 11 U.S.C.

§ 365. Delays in formulating, filing,
32 • REORGANIZATION UNDER THE BANKRUPTCY CODE

and obtaining confirmation of a plan

often cause creditors to file motions for

relief from stay or motions to convert

the case to a chapter 7 or to dismiss the

case altogether.

ADVERSARY

PROCEEDINGS

Frequently, the debtor in possession will

institute a lawsuit, known as an adversary proceeding, to recover money or

property for the estate. Adversary proceedings may take the form of lien

avoidance actions, actions to avoid

preferences, actions to avoid fraudulent

transfers, or actions to avoid post petition transfers. Such proceedings are

governed by Part VII of the Federal

Rules of Bankruptcy Procedure. At

times, a creditors’ committee may be

authorized by the bankruptcy court to

pursue these actions against insiders of

the debtor if the plan provides for the

committee to do so or if the debtor has

refused a demand to do so. Creditors

may also initiate adversary proceedings

by filing complaints to determine the

validity or priority of a lien, to revoke

an order confirming a plan, to determine the dischargeability of a debt, to

obtain an injunction, or to subordinate

a claim of another creditor.

CLAIMS

A claim is a right to payment or a right

to an equitable remedy for a failure of

performance if the breach gives rise to a

right to payment. 11 U.S.C. § 101(5).

In some instances, a creditor must file a

proof of claim form along with documentation evidencing the validity and

amount of the claim. When proofs of

claim are required to be filed, creditors

must file the proofs of claim with the

bankruptcy clerk in the district where

the case is pending. The clerk is

required to keep a list of claims filed in

a case when it appears that there will be

a distribution to unsecured creditors.

Fed. R. Bankr. P. 5003(b). Most creditors whose claims are scheduled (i.e.,

claims listed by the debtor on the

debtor’s schedules), but not listed as

disputed, contingent, or unliquidated,

need not file claims because the schedule of liabilities is deemed to constitute

evidence of the validity and amount of

those claims. 11 U.S.C. § 1111. Any

creditor whose claim is not scheduled,

or is scheduled as disputed, contingent,

or unliquidated, must file a proof of

claim in order to be treated as a creditor for purposes of voting on the plan

and distribution under it. Fed. R.

Bankr. P. 3003(c)(2). If a scheduled

creditor chooses to file a claim, a properly filed proof of claim supersedes any

scheduling of that claim. Fed. R. Bankr.

P. 3003(c)(4). It is the responsibility of

the creditor to determine whether the

claim is accurately listed. The debtor

must provide notification to those creditors whose names are added and

whose claims are listed as a result of an

amendment to the schedules. The notification also should advise such creditors of their right to file proofs of claim

and that their failure to do so may prevent them from voting upon the

debtor’s plan of reorganization or participating in any distribution under that

plan. When a debtor amends the schedule of liabilities to add a creditor or

change the status of any claims to disputed, contingent, or unliquidated

claims, the debtor must provide notice

of the amendment to any entity affected. Fed. R. Bankr. P. 1009(a).
REORGANIZATION UNDER THE BANKRUPTCY CODE • 33

EQUITY SECURITY

HOLDERS

An equity security holder is a holder of

an equity security of the debtor.

Examples of an equity security are a

share in a corporation, an interest of a

limited partner in a limited partnership,

or a right to purchase, sell, or subscribe

to a share, security, or interest of a share

in a corporation or an interest in a limited partnership. 11 U.S.C §§ 101(16) ,

(17). An equity security holder may vote

on the plan of reorganization and may

file a proof of interest, rather than a

proof of claim. A proof of interest is

deemed filed for any interest that

appears in the debtor’s schedules, unless

it is scheduled as disputed, contingent,

or unliquidated. 11 U.S.C. § 1111. An

equity security holder whose interest is

not scheduled or scheduled as disputed,

contingent, or unliquidated must file a

proof of interest in order to be treated

as a creditor for purposes of voting on

the plan and distribution under it. Fed.

R. Bankr. P. 3003(c)(2). A properly filed

proof of interest supersedes any scheduling of that interest. Fed. R. Bankr. P.

3003(c)(4). Generally, most of the provisions that apply to proofs of claim, as

discussed above, are also applicable to

proofs of interest.

CONVERSION OR

DISMISSAL

A debtor in a case under chapter 11 has

a one-time absolute right to convert the

chapter 11 case to a case under chapter 7

unless (1) the debtor is not a debtor in

possession, (2) the case originally was

commenced as an involuntary case under

chapter 11, or (3) the case was converted

to a case under chapter 11 other than

at the debtor’s request. 11 U.S.C.

§ 1112(a). A debtor in a chapter 11 case

does not have an absolute right to have

the case dismissed upon request.

Generally, upon the request of a party

in interest in the case or the United

States trustee, after notice and hearing

and “for cause,” the court may convert

a chapter 11 case to a case under chapter 7 or dismiss the case, whichever is in

the best interest of creditors and the

estate. 11 U.S.C. § 1112(b). The court

may convert or dismiss a case “for

cause” when there is a continuing loss

to the estate, an inability to effectuate a

plan, unreasonable delay that is prejudicial to creditors, denial or revocation of

confirmation, or inability to consummate a confirmed plan.

There are important exceptions to

the conversion process in a chapter 11

case. One exception is that, unless the

debtor requests the conversion, section

1112(c) of the Code prohibits the court

from converting a case involving a

farmer or charitable institution to a liquidation case under chapter 7.

THE DISCLOSURE

STATEMENT

The filing of a written disclosure statement is preliminary to the voting on a

plan of reorganization, and the disclosure statement must provide “adequate

information” concerning the affairs of

the debtor to enable the holder of a

claim or interest to make an informed

judgment about the plan. 11 U.S.C.

§ 1125. After the disclosure statement is

filed, the court must hold a hearing to

determine whether the disclosure statement should be approved. Acceptance

or rejection of a plan cannot be solicited without prior court approval of the

written disclosure statement. 11 U.S.C.

§ 1125(b). After the disclosure statement has been approved, the debtor or
34 • REORGANIZATION UNDER THE BANKRUPTCY CODE

proponent of a plan can begin to solicit

acceptances of the plan, and creditors

may also solicit rejections of the plan.

Fed. R. Bankr. P. 3017(d) requires that,

upon approval of a disclosure statement, the following must be mailed to

the United States trustee and all creditors and equity security holders: (1) the

plan, or a court approved summary of

the plan; (2) the disclosure statement

approved by the court; (3) notice of the

time within which acceptances and

rejections of the plan may be filed; and

(4) such other information as the court

may direct, including any opinion of the

court approving the disclosure statement or a court-approved summary of

the opinion. Fed. R. Bankr. P. 3017(d).

In addition, the debtor must mail to the

creditors and equity security holders

entitled to vote on the plan or plans (1)

notice of the time fixed for filing objections; (2) notice of the date and time for

the hearing on confirmation of the plan;

and (3) a ballot for accepting or rejecting the plan and, if appropriate, a designation for the creditors to identify their

preference among competing plans. Id.

However, in a small business case, the

court may conditionally approve a disclosure statement subject to final

approval after notice and a combined

disclosure statement/plan confirmation

hearing. 11 U.S.C. § 1125(F).

ACCEPTANCE OF THE PLAN

OF REORGANIZATION

As noted earlier, during the first 120-

day period after the filing of the voluntary bankruptcy petition, which filing

also acts as the order of relief, only the

debtor in possession may file a plan of

reorganization. The debtor in possession has 180 days after the filing of the

voluntary petition (or in a case commenced by an involuntary petition, after

the order for relief) to obtain acceptances of the plan. 11 U.S.C. § 1121.

For cause, the court may extend or

reduce this exclusive period. 11 U.S.C.

§ 1121(d). The exclusive right of the

debtor in possession to file a plan is lost

and any party in interest, including the

debtor, may file a plan if and only if (1)

a trustee has been appointed in the case,

(2) the debtor has not filed a plan within the 120-day exclusive period or any

extension granted by the court, or (3)

the debtor has not filed a plan which

has been accepted by each class of

claims or interests that is impaired

under the plan within the 180-day period or any extensions granted by the

court. 11 U.S.C. § 1121.

If the exclusive period expires before

the debtor has filed and obtained

acceptance of a plan, other parties in

interest in a case, such as the creditors’

committee or a creditor, may file a

plan. Such a plan may compete with a

plan filed by another party in interest

or by the debtor. If a trustee is appointed, the trustee is responsible for filing a

plan, a report of why the trustee will

not file a plan, or a recommendation

for the conversion or dismissal of the

case. 11 U.S.C. § 1106(a)(5). A proponent of a plan is subject to the same

requirements as the debtor with respect

to disclosure and solicitation.

It should be noted that, in a chapter

11 case, a liquidating plan is permissible. Such a plan often allows the debtor

in possession to liquidate the business

under more economically advantageous circumstances than a chapter 7

liquidation. It also permits the creditors

to take a more active role in fashioning

the liquidation of the assets and the
REORGANIZATION UNDER THE BANKRUPTCY CODE • 35

distribution of the proceeds than in a

chapter 7 case.

Section 1123(a) of the Bankruptcy

Code lists the mandatory provisions of

a chapter 11 plan and section 1123(b)

lists the discretionary provisions.

Section 1123(a)(1) provides that a

chapter 11 plan shall designate classes

of claims and interests for treatment

under the reorganization. Generally, a

plan will classify claim holders as

secured creditors, unsecured creditors

entitled to priority, general unsecured

creditors, and equity security holders.

Under section 1126(c) of the Code,

an entire class of claims accepts a plan

if the plan is accepted by creditors that

hold at least two-thirds in amount and

more than one-half in number of the

allowed claims in the class. Under section 1129(a)(10), if there are impaired

classes of claims, the court cannot confirm a plan unless the plan has been

accepted by at least one class of noninsiders who hold impaired claims.

“Impaired” claims are claims that are

not going to be paid completely or in

which some legal, equitable, or contractual right is altered. Moreover,

under section 1126(f), holders of unimpaired claims are deemed to have

accepted the plan.

Under section 1127(a) of the

Bankruptcy Code, the proponent may

modify the plan at any time before

confirmation, but the plan as modified

must meet all the requirements of

chapter 11. Federal Rule of

Bankruptcy Procedure 3019 provides

that, when there is a proposed modification after balloting has been conducted and the court finds after a hearing that the proposed modification

does not adversely affect the treatment

of any creditor who has not accepted

the modification in writing, the modification shall be deemed to have been

accepted by all creditors who previously accepted the plan. If it is determined

that the proposed modification does

have an adverse effect on the claims of

nonconsenting creditors, then another

balloting must take place.

Because more than one plan may

be submitted to the creditors for

approval, Federal Rule of Bankruptcy

Procedure 3016(a) requires that every

proposed plan and modification

be dated and identified with the name

In a chapter 11

case, a liquidating

plan is permissible.

Such a plan often

allows the debtor

in possession to

liquidate the

business under

more economically

advantageous 

circumstances

than a chapter 7

liquidation.
36 • REORGANIZATION UNDER THE BANKRUPTCY CODE

of the entity or entities submitting

such plan or modification. When competing plans are presented and meet

the requirements for confirmation,

the court must consider the preferences

of the creditors and equity security

holders in determining which plan

to confirm.

Any party in interest may file an

objection to confirmation of a plan.

The Bankruptcy Code requires the

court, after notice, to hold a hearing on

the confirmation of a plan. If no objection to confirmation has been timely

filed, the Code allows the court to

determine that the plan has been proposed in good faith and according to

law. Fed. R. Bankr. P. 3020(b)(2).

Before confirmation can be granted, the

court must be satisfied that there has

been compliance with all the other

requirements of confirmation set forth

in section 1129 of the Code, even in the

absence of any objections. In order to

confirm the plan, the court must find

that (1) the plan is feasible, (2) it is proposed in good faith, and (3) the plan

and the proponent of the plan are in

compliance with the Code. In addition,

the court must find that confirmation

of the plan is not likely to be followed

by liquidation or the need for further

financial reorganization.

THE DISCHARGE

While some courts have a practice of

issuing a discharge order in a case

involving an individual, a separate

order of discharge is usually not

entered in a chapter 11 case. Section

1141(d)(1) specifies that the confirmation 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

make plan payments and is bound by

the provisions of the plan of reorganization. The confirmed plan creates new

contractual rights, replacing or superseding pre-bankruptcy contracts.

There are, of course, exceptions to

the general rule that an order confirming a plan operates as a discharge.

Confirmation of a plan of reorganization will discharge any type of

debtor—corporation, partnership, or

individual—from most types of prepetition debts. It does not, however, discharge an individual debtor from any

debt made nondischargeable by section

523 of the Bankruptcy Code.

Confirmation does not discharge the

Confirmation 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 make

plan payments and

is bound by the

provisions of the plan

of reorganization.
REORGANIZATION UNDER THE BANKRUPTCY CODE • 37

debtor if the plan is a liquidation plan,

as opposed to one of reorganization,

and the debtor is not an individual.

When the debtor is an individual, confirmation of a liquidation plan will

effect a discharge unless grounds

would exist for denying the debtor a

discharge if the case were proceeding

under chapter 7 instead of chapter 11.

11 U.S.C. §§ 1141(d)(2), 727(a).

POSTCONFIRMATION

MODIFICATION OF

THE PLAN

At any time after confirmation and

before “substantial consummation” of

a plan, the proponent of a plan may

modify a plan if the modified plan

would meet certain Bankruptcy Code

requirements. 11 U.S.C. § 1127(b).

This should be distinguished from preconfirmation modification of the plan.

A modified postconfirmation plan does

not automatically become the plan. A

modified postconfirmation plan in a

chapter 11 case becomes the plan only

“if circumstances warrant such modification” and the court, after notice and

hearing, confirms the plan as modified

pursuant to chapter 11 of the Code.

POSTCONFIRMATION

ADMINISTRATION

Federal Rule of Bankruptcy Procedure

3020(d) provides that, “[n]otwithstanding the entry of the order of confirmation, 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 proceedings 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

possession or a trustee to report on the

progress made in implementing a plan

after confirmation. A chapter 11 trustee

or debtor in possession has a number of

responsibilities to perform after confirmation, including consummating the

plan, reporting on the status of consummation, and applying for a final decree.

REVOCATION OF THE

CONFIRMATION ORDER

A revocation of the confirmation order

is an undoing or cancellation of the

confirmation of a plan. A request for

revocation of confirmation, if made at

all, must be made by a party in interest

within 180 days of confirmation. The

court, after notice and hearing, may

revoke a confirmation order “if and

only if [the confirmation] order was

procured by fraud.” 11 U.S.C. § 1144.

THE FINAL DECREE

A final decree closing the case must be

entered after the estate has been “fully

administered.” Fed. R. Bankr. P. 3022.

Local bankruptcy court policies may

determine when the final decree should

be entered and the case closed.
BACKGROUND

In tailoring chapter 12 to meet the economic realities of family farming, this

law has eliminated many of the barriers

that family farmers had faced when

seeking to reorganize successfully

under either chapter 11 or 13 of the

Bankruptcy Code. For example, chapter 12 is more streamlined, less complicated, and less expensive than chapter

11, which is better suited to the large

corporate reorganization. In addition,

few family farmers find chapter 13 to

be advantageous, because it was

designed for wage earners who have

smaller debts than those facing family

farmers. In chapter 12, Congress

sought to combine the features of the

Bankruptcy Code which can provide a

framework for successful family farm

reorganizations. At the time of the

enactment of chapter 12, Congress

could not be sure whether chapter 12

relief for the family farmer would be

required indefinitely. Accordingly, the

law (which first provided that no chapter 12 cases could be filed after

September 30, 1993) currently provides

that no cases may be filed under chapter 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.

Family Farmer

Bankruptcy

Chapter 12 of the

Bankruptcy Code was

enacted by Congress in

1986, specifically to meet

the needs of financially

distressed family farmers.

The primary purpose of

this legislation was to

give family farmers facing

bankruptcy a chance to

reorganize their debts

and keep their farms. 

12

CHAPTE R
FAMILY FARMER BANKRUPTCY • 39

§§ 101(18), 109(f). The purpose of this

requirement is to ensure that the debtor’s

annual income is sufficiently stable and

regular to permit the debtor to make

payments under a chapter 12 plan.

Allowance is made under chapter 12,

however, for situations in which family

farmers may have income that is seasonal in nature. Relief under this chapter is

voluntary; thus, only the debtor may file

a petition under chapter 12.

Under the Bankruptcy Code, those

eligible to file as “family farmers” fall

into two categories: (1) an individual or

individual and spouse and (2) a corporation or partnership. Those falling into

the first category must meet each of the

following four criteria as of the date the

petition is filed in order to qualify for

relief under chapter 12.

1. The individual or husband and wife

must be engaged in a farming operation.

2. The total debts (secured and unsecured) of that farming operation must

not exceed $1.5 million.

3. Not less than 80% of the total debts

which are fixed in amount must be

related to the farming operation.

4. More than 50% of the gross income

of the individual or the husband and

wife for the receding tax year must have

come from the farming operation.

In order for a corporation or partnership to fall within the second category of debtors eligible to file as “family farmers,” the corporation or partnership must meet each of the following criteria as of the date of the filing of

the petition.

1. More than one-half of the outstanding stock or equity in the corporation or

partnership must be owned by one family or by one family and its relatives.

2. The family or the family and its relatives must conduct the farming operation.

3. More than 80% of the value of the

corporate or partnership assets must be

related to the farming operation.

4. The total indebtedness of the corporation or partnership must not exceed

$1.5 million.

5. Not less than 80% of the corporation’s or partnership’s total debts which

are fixed in amount must come from the

farming operation owned or operated by

the corporation or partnership.

6. If the corporation issues stock, the

stock cannot be publicly traded.

HOW CHAPTER 12 WORKS

A chapter 12 case begins with the filing

of a petition and several additional

forms, such as schedules of assets and

liabilities, a statement of financial

affairs, a schedule of current income

and expenditures, and a schedule of

executory contracts and unexpired leases. Bankruptcy Rule 1007(b)(1). The

petition and other forms are filed with

the bankruptcy court serving the area

where the individual lives or where the

corporation or partnership debtor has

its principal place of business or principal assets. The exact filing requirements in each jurisdiction are specified

in local rules of court which can be

obtained from the clerk’s office.

(Official Bankruptcy Forms can be pur-
40 • FAMILY FARMER BANKRUPTCY

chased at a legal stationery store. They

are not available from the court.) A

husband and wife may file one joint

petition. 11 U.S.C. § 302(a).

In order to complete the Official

Bankruptcy Forms which make up

the petition and schedules, the debtor

will need to compile the following

information:

1. A list of all creditors;

2. The source, amount, frequency, and

reliability of the debtor’s income;

3. A list of all of the debtor’s property;

and

4. A detailed list of the debtor’s monthly farming and living expenses, i.e.,

food, shelter, utilities, taxes, transportation, medicine, feed, fertilizer, etc.

When a husband and wife intend to

file a single, joint petition, they should

gather the above-detailed data for both

spouses. Even when only one spouse

files, however, the income and expenses

of the non-filing spouse should be

included in the petition and schedules,

so that the court can assess accurately

the debtor’s financial responsibilities.

Currently, the courts are required to

charge a $200 filing fee. This fee should

be paid in full upon filing or, with the

court’s permission, the fee for an individual debtor may be paid in up to

four installments. Bankruptcy Rule

1006(b)(1). If a joint petition is filed,

only one $200 fee is charged.

Upon the filing of the petition, an

impartial trustee is appointed by the

court or the United States trustee to

administer the case. 11 U.S.C. § 1202;

28 U.S.C. § 586(b). As in chapter 13,

the trustee’s primary responsibility is to

act as a disbursing agent, receiving payments from debtors and making distributions to creditors.

The filing of the petition also “automatically stays” most actions by creditors to collect money or property owed

to them. 11 U.S.C. § 362. Creditors, by

law, generally cannot initiate or continue any lawsuits, wage garnishments, or

even telephone calls demanding payment. Creditors (whose identities and

mailing addresses are provided by the

debtor) will receive notice of the filing

of the petition from the court.

The debtor must file a plan of

repayment with the petition or within

90 days afterward, unless the court

determines that the need for an extension is attributable to circumstances

for which the debtor should not be

held accountable. 11 U.S.C. § 1221.

Plans, which must be approved by the

court, provide for payments of fixed

amounts to the trustee on a regular

basis. The trustee then distributes the

funds to creditors according to the

terms of the plan.

There are three types of debt:

secured, priority, and unsecured.

Secured debts are those for which the

creditor has the right to pursue specific

pledged property upon default. Priority

debts are those granted special status

by the bankruptcy law, such as most

taxes and the costs of the bankruptcy

proceeding. Unsecured debts generally

are characterized as those debts for

which credit was extended based solely

on the creditor’s assessment of the

debtor’s future ability to pay. 

The debtor’s plan usually lasts three

to five years. It must provide for payment in full to all priority creditors.

11 U.S.C. § 1222(a)(2). The plan need
FAMILY FARMER BANKRUPTCY • 41

not provide that unsecured creditors

be paid in full, as long as the debtor

pays under the plan all projected “disposable income” over the three to five

years that the plan is in effect and as

long as the plan provides that unsecured creditors are to receive at least

as much as they would receive if the

debtor’s nonexempt assets were liquidated under chapter 7. 11 U.S.C.

§ 1225. “Disposable income” is

defined as income which is not reasonably necessary for the maintenance or support of the debtor or

his/her dependents or for the payment

of expenditures necessary for the continuation, preservation, and operation

of the debtor’s business. 11 U.S.C.

§ 1225(b)(2)(A) and (B).

Secured creditors must be paid at

least as much as the value of the collateral pledged for the debt. One of the

features of Chapter 12 is that, in certain circumstances, payments to

secured creditors can continue longer

than the three-to-five-year period the

plan provides for payment to unsecured and priority creditors.

Approximately 20 to 35 days after

the petition is filed, a “meeting of creditors” is held. The debtor must attend

this meeting, at which creditors may

appear and ask questions regarding the

debtor’s financial affairs and the proposed terms of the plan. 11 U.S.C.

§ 343; Bankruptcy Rule 4002. (If a husband and wife have filed a joint petition, both must attend the creditors’

meeting.) The trustee will also attend

the meeting and question the debtor. In

order to preserve their independent

judgment, bankruptcy judges are prohibited from attending meetings of creditors. 11 U.S.C. § 341(c). Any problems

with the plan are typically resolved during or shortly after the creditors’ meeting. Generally, problems may be avoided if the petition and plan are complete

and accurate and the trustee has been

consulted prior to the meeting.

Within 45 days after the filing of the

plan, the presiding bankruptcy judge

must determine at a “confirmation

hearing” whether the plan is feasible

and meets the standards for confirmation under the Bankruptcy Code.

11 U.S.C. §§ 1224 and 1225. Creditors

may appear at the hearing and object

to confirmation. While a variety of

objections may be made, the typical

The debtor must file

a plan of repayment

with the petition

or within 90 days

afterward, unless

the court determines

that the need for

an extension is

attributable to

circumstances for

which the debtor

should not be held

accountable.
42 • FAMILY FARMER BANKRUPTCY

arguments are that payments offered

under the plan are less than creditors

would receive if the debtor’s assets

were liquidated or that the plan does

not commit all of the debtor’s disposable income for the three-to-five-year

period of the plan.

If the plan is confirmed by the bankruptcy judge, the trustee commences

distribution of the funds the trustee

has received from the debtor. If the

plan is not confirmed, the funds paid

to the trustee are returned to the

debtor after deducting the trustee’s

percentage fee and any unpaid claim

allowed for administrative expenses.

11 U.S.C. § 1226(a).

On occasion, changed circumstances

will affect a debtor’s ability to make

payments or a debtor may inadvertently have failed to list all creditors. In

such instances, the plan may be modified either before or after confirmation.

11 U.S.C. §§ 1223 and 1229.

MAKING THE PLAN WORK

Once the court confirms the plan, it is

incumbent upon the debtor to make

the plan succeed. The debtor must

make regular payments to the trustee.

Further, while confirmation of the plan

entitles the debtor to retain property as

long as payments are made, 11 U.S.C.

§ 1227(b), the debtor should not incur

any significant new credit obligations

without consulting the trustee, because

they may impact upon the successful

execution of the plan. In any event,

failure to make the plan payments

may result in dismissal of the case.

11 U.S.C. § 1208(c). In addition, the

court may dismiss the case or convert

the case to a liquidation case under

chapter 7 of the Bankruptcy Code

upon a showing that the debtor has

committed fraud in connection with

the case. 11 U.S.C. § 1208(d).

THE CHAPTER 12

DISCHARGE

As is the case under chapter 13, upon

successful completion of all payments

under a chapter 12 plan, the debtor will

receive a “discharge” which extinguishes the debtor’s obligation to pay any

unsecured debts that were included in

Upon successful

completion of all

payments under a

chapter 12 plan, the

debtor will receive a

“discharge” which

extinguishes the

debtor’s obligation

to pay any unsecured

debts that were

included in the plan,

even though they

may not have been

paid in full.
FAMILY FARMER BANKRUPTCY • 43

the plan, even though they may not

have been paid in full. 11 U.S.C.

§ 1228. After the discharge has been

granted, those creditors whose claims

were provided for in full or in part

under the plan no longer may initiate

or continue any legal or other action

against the debtor to collect the discharged obligations.

Certain categories of debts are not

discharged in chapter 12 proceedings.

11 U.S.C. § 1228(a). Those categories

include debts for alimony and child

support; money obtained through filing false financial statements; debts for

willful and malicious injury to person

or property; debts for death or personal injury caused by the debtor’s operation of a motor vehicle while the

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 discharged should be paid in full under a

plan. With respect to secured obligations, 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 completed due to circumstances for which

the family farmer “should not justly

be held accountable,” 11 U.S.C.

§ 1228(b)(1), and other statutory criteria have been met, a family farmer

may be excused from completing payments under a plan of reorganization.

If the court finds that such circumstances exist and that unsecured creditors already have received at least

what they would have received if the

debtor’s estate had been liquidated

under chapter 7 of the Bankruptcy

Code, the bankruptcy court may grant

the debtor a discharge of all unsecured

debts provided for in the plan or disallowed by the court, with the exception

of those types of debts which are

excepted from discharge. Injury or illness that precludes employment sufficient to fund even a modified plan

may serve as the basis for a discharge

under section 1228(c). A discharge

granted under section 1228(c) is often

referred to as a “hardship discharge.”
In the more than 60 years

since Congress established

a federal mechanism for

the resolution of municipal

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.

9

CHAPTE R

Municipality

Bankruptcy

HISTORY OF CHAPTER 9

The first municipal bankruptcy legislation was enacted in 1934 during the

Great Depression. Pub. L. No. 251, 48

Stat. 798 (1934). Although Congress

took care to draft the legislation so as

not to interfere with the sovereign powers of the states as guaranteed by the

Tenth Amendment to the Constitution,

the Supreme Court held the 1934

Act unconstitutional as an improper

interference with the sovereignty of

the states. Ashton v. Cameron County

Water Improvement District No. 1,

298 U.S. 513 (1936). Congress enacted

a revised Municipal Bankruptcy Act in

1937, Pub. L. No. 302, 50 Stat. 653

(1937), which was upheld by the

Supreme Court. United States v.

Bekins, 304 U.S. 27 (1938). The law

has been amended several times since

1937, most recently in 1994 (amending

section 109(c)) as part of the

Bankruptcy Reform Act of 1994, Pub.

L. No. 103–394, 108 Stat. 4106 (codified as amended at 11 U.S.C. §§ 901 to

946) (1994). In the more than 60 years

since Congress established a federal

mechanism for the resolution of municipal 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.
MUNICIPALITY BANKRUPTCY • 45

PURPOSE OF MUNICIPAL

BANKRUPTCY

The purpose of chapter 9 is to provide

a financially-distressed municipality

protection from its creditors while it

develops and negotiates a plan for

adjusting its debts. Reorganization of

the debts of a municipality is typically

accomplished either by extending debt

maturities, reducing the amount of

principal or interest, or refinancing the

debt by obtaining a new loan.

Although similar to other chapters in

some respects, chapter 9 is significantly

different in that there is no provision in

the law for liquidation of the assets of

the municipality and distribution of the

proceeds to creditors. Such a liquidation or dissolution would undoubtedly

violate the Tenth Amendment to the

Constitution and the reservation to the

states of sovereignty over their internal

affairs. Indeed, due to the severe limitations placed upon the power of the

bankruptcy court in chapter 9 cases

(required by the Tenth Amendment and

the Supreme Court’s decisions in cases

upholding municipal bankruptcy legislation), the bankruptcy court generally

is not as active in managing a municipal bankruptcy case as it is in corporate

reorganizations under chapter 11. The

functions of the bankruptcy court in

chapter 9 cases are generally limited to

approval of the petition (if the debtor is

eligible), confirmation of a plan of debt

adjustment, and ensuring implementation of the plan. As a practical matter,

however, the municipality may consent

to have the court exercise jurisdiction

in many of the traditional areas of

court oversight in bankruptcy, in order

to obtain the protection of court orders

and eliminate the need for multiple

forums to decide issues.

MEDIA INTEREST

The news media frequently is more

interested in municipal bankruptcy

cases than in cases filed by individuals

or small businesses. As a consequence,

some courts have a written policy for

court personnel regarding the information that may or may not be

released to the media in a case filed

under chapter 9. Some courts also designate a public information officer to

act as the contact person for all media

inquiries concerning the municipal

bankruptcy case.

ELIGIBILITY

Only a “municipality” can file for relief

under chapter 9. The term “municipality” is defined in the Code to mean

“political subdivision or public agency

or instrumentality of a State.” 11 U.S.C.

§ 101(40). The definition is broad

enough to include cities, counties, townships, school districts, and public

improvement districts. It also includes

revenue-producing bodies that provide

services which are paid for by users

rather than by general taxes, such as

bridge authorities, highway authorities,

and gas authorities.

There are three additional eligibility

requirements for chapter 9:

1. the entity must be specifically authorized to be a debtor under such chapter

by State law or by a governmental officer or organization empowered by

State law to authorize such entity to be

a debtor under such chapter,

2. the municipality must be insolvent as

defined in 11 U.S.C. § 101(32)(C), and

3. the municipality must desire to effect

a plan to adjust such debts and either
46 • MUNICIPALITY BANKRUPTCY

• has obtained the agreement of creditors holding at least a majority in

amount of the claims of each class that

the debtor intends to impair under a

plan in a case under chapter 9;

• has negotiated in good faith with

creditors and has failed to obtain the

agreement of creditors holding at least

a majority in amount of the claims of

each class that the debtor intends to

impair under a plan;

• is unable to negotiate with creditors because such negotiation is

impracticable; or

• reasonably believes that a creditor

may attempt to obtain a preference.

11 U.S.C. § 109(c).

COMMENCEMENT

OF THE CASE

Municipalities must voluntarily seek

protection under the Bankruptcy Code.

11 U.S.C. §§ 303, 901(a). They may

file a petition only under chapter 9. A

case under chapter 9 concerning an

unincorporated tax or special assessment district that does not have such

district’s own officials is commenced by

the filing of a voluntary “petition under

this chapter by such district’s governing

authority or the board or body having

authority to levy taxes or assessments

to meet the obligations of such district.” 11 U.S.C. § 921(a).

A municipal debtor is required to file

a list of creditors. 11 U.S.C. § 924.

Normally, the list of creditors is filed

with the petition. However, in some situations, the debtor may not have adequate time to prepare a list of creditors

in the form and with the detail required

by the Bankruptcy Rules. Thus, the

Bankruptcy Rules permit the court to

fix a time within which the list must be

filed. Fed. R. Bankr. P. 1007.

ASSIGNMENT OF CASE TO

A BANKRUPTCY JUDGE

One significant difference between

chapter 9 cases and cases filed under

other chapters is that the clerk of

court does not automatically assign

the case to a particular judge. “The

chief judge of the court of appeals for

the circuit embracing the district in

which the case is commenced [designates] the bankruptcy judge to conduct the case.” 11 U.S.C. § 921(b).

This provision was designed to remove

politics from the issue of which judge

will preside over the chapter 9 case of

a major municipality and to ensure

that a municipal case will be handled

by a judge who has the time and capability of doing so. S. Rep. No. 458,

94th Cong., 1st Sess. 15 (1975) (legislative history of Bankruptcy Act—

Debts of Municipalities, Pub. L. No.

94–260, 90 Stat. 315 (1976)). See also

S. Rep. No. 989, 95th Cong., 2d Sess.

110 (1978).

NOTICE OF

CASE/OBJECTIONS/

ORDER FOR RELIEF

The Bankruptcy Code requires that

notice be given of the commencement

of the case and the order for relief.

11 U.S.C. § 923. The Bankruptcy Rules

provide that the clerk, or such other

person as the court may direct, is to give

notice. Fed. R. Bankr. P. 2002(f). Such

notice must also be published “at least

once a week for three successive weeks

in at least one newspaper of general circulation published within the district in

which the case is commenced, and in

such other newspaper having a general

circulation among bond dealers and

bondholders as the court designates.”

11 U.S.C. § 923. The court typically
MUNICIPALITY BANKRUPTCY • 47

enters an order designating who is to

give and receive notice by mail and

identifying the newspapers in which the

additional notice is to be published.

Fed. R. Bankr. P. 9008.

The Bankruptcy Code permits objections to the petition to be filed.

11 U.S.C. § 921(c). Typically, objections concern issues like whether negotiations have been conducted in good

faith, whether the state has authorized

the municipality to file, and whether

the petition was filed in good faith. If

an objection to the petition is filed, the

court must hold a hearing on the objection. Id. The court may dismiss a petition if it determines that the debtor did

not file the petition in good faith or

that the petition does not meet the

requirements of title 11. Id.

If the petition is not dismissed upon

an objection, the Bankruptcy Code

requires the court to order relief, allowing the case to proceed under chapter 9.

11 U.S.C. § 921(d).

AUTOMATIC STAY

The automatic stay of section 362 of

the Bankruptcy Code is applicable in

chapter 9 cases. 11 U.S.C. §§ 362(a),

901(a). The stay operates to stop all

collection actions against the debtor

and its property upon the filing of the

petition. There is another provision of

the Code, however, which expands the

stay to entities other than the debtor.

The additional automatic stay provisions under section 922(a) prohibit

actions against officers and inhabitants of the debtor if the action seeks

to enforce a claim against the debtor.

Thus, the stay prohibits a creditor

from bringing a mandamus action

against an officer of a municipality on

account of a prepetition debt. It also

prohibits a creditor from bringing an

action against an inhabitant of the

debtor to enforce a lien on or arising

out of taxes or assessments owed to

the debtor. Section 922(d) of title 11

limits the applicability of the stay.

Pursuant to that section, a chapter 9

petition does not operate to stay application of pledged special revenues to

payment of indebtedness secured by

such revenues. Thus, an indenture

trustee or other paying agent may

apply pledged funds to payments coming due or distribute the pledged funds

to bondholders without violating the

automatic stay. 

PROOFS OF CLAIM

In a chapter 9 case, the court fixes the

time within which proofs of claim or

interest may be filed. Fed. R. Bankr. P.

3003(c)(3). Many creditors may not be

required to file a proof of claim in a

chapter 9 case. For example, a proof of

claim is deemed filed if it appears on

the list of creditors filed by the debtor,

unless the debt is listed as disputed,

contingent, or unliquidated. 11 U.S.C.

§ 925. Thus, a creditor must file a

proof of claim, if the creditor’s claim

appears on the list of creditors as disputed, contingent, or unliquidated.

COURT’S LIMITED POWER

Two of chapter 9’s provisions are

designed to recognize the court’s limited

power over operations of the debtor:

sections 903 and 904. Section 904 of the

Code limits the power of the bankruptcy court to “interfere with (1) any of the

political or governmental powers of the

debtor; (2) any of the property or revenues of the debtor; or (3) the debtor’s

use or enjoyment of any income-producing property,” unless the debtor consents
48 • MUNICIPALITY BANKRUPTCY

or the plan so provides. The provision

makes it clear that the debtor’s day-today activities are not subject to court

approval and that the debtor may borrow money without court authority. In

addition, the court cannot appoint a

trustee (except for limited purposes

specified in section 926(a)) and cannot

convert the case to a liquidation proceeding. The court also cannot interfere

with the operations of the debtor or

with the debtor’s use of its property and

revenues. This is due, at least in part, to

the fact that in a chapter 9 case there is

no property of the estate and thus no

estate to administer. 11 U.S.C. § 902(1).

Moreover, the chapter 9 debtor may

employ professionals without court

approval, and the only court review of

fees is in the context of plan confirmation, when the court determines the reasonableness of the fees. The restrictions

imposed by section 904 are necessary in

order to ensure the constitutionality of

chapter 9 and to avoid the possibility

that the court might substitute its control over the political or governmental

affairs or property of the debtor for that

of the state and the elected officials of

the municipality. 

Similarly, section 903 of the Code

states that “chapter [9] does not limit

or impair the power of a State to control, by legislation or otherwise, a

municipality of or in such State in the

exercise of the political or governmental powers of the municipality, including expenditures for such exercise,”

with two exceptions—a state law prescribing a method of composition of

municipal debt does not bind any nonconsenting creditor, nor does any judgment entered under such state law bind

a nonconsenting creditor. 

ROLE OF THE UNITED

STATES TRUSTEE/

BANKRUPTCY

ADMINISTRATOR

The role of the United States trustee in

chapter 9 cases is typically more limited than in chapter 11 cases. Although

the United States trustee appoints a

creditors’ committee, the United States

trustee does not examine the debtor at

a meeting of creditors (there is no meeting of creditors), does not have the

authority to move for appointment of a

trustee or examiner or for conversion

of the case, and does not supervise the

administration of the case. Nor does

Although similar

to other chapters

in some respects,

chapter 9 is

significantly different

in that there is no

provision in the

law for liquidation

of the assets of the

municipality and

distribution of the

proceeds to creditors.
MUNICIPALITY BANKRUPTCY • 49

the United States trustee monitor the

financial operations of the debtor or

review the fees of professionals retained

in the case. Bankruptcy Administrators

serve a similar limited function in chapter 9 cases filed in the six judicial districts in the states of Alabama and

North Carolina.

ROLE OF CREDITORS

The creditors’ role is more limited in

chapter 9 than in other cases. There is

no first meeting of creditors and creditors may not propose a plan of adjustment. If certain requirements are met,

the debtor’s plan of adjustment is binding on dissenting creditors. The chapter

9 debtor has more freedom to operate

without court-imposed restrictions. In

each chapter 9 case, however, there is a

creditors’ committee that has powers

and duties that are very similar to those

of a committee in a chapter 11 case.

These powers and duties include selecting and authorizing the employment of

one or more attorneys, accountants, or

other agents to represent the committee,

consulting with the debtor concerning

administration of the case, investigating

the acts, conduct, assets, liabilities, and

financial condition of the debtor, participating in the formulation of a plan, and

performing such other services as are

in the interest of those represented.

11 U.S.C. §§ 901(a), 1103.

INTERVENTION/RIGHT OF

OTHERS TO BE HEARD

When cities or counties file for relief

under chapter 9, there may be a great

deal of interest in the case from entities

wanting to appear and be heard. The

Bankruptcy Rules provide that “[t]he

Secretary of the Treasury of the United

States may, or if requested by the court

shall, intervene in a chapter 9 case.” Fed.

R. Bankr. P. 2018(c). In addition,

“[r]epresentatives of the state in which

the debtor is located may intervene in a

chapter 9 case. Id. In addition, section

1109 of the Bankruptcy Code permits

the Securities and Exchange Commission

to appear and be heard on any issue and

gives parties in interest the right to

appear and be heard on any issue in a

case. 11 U.S.C. § 901(a). Among those

that may be interested in being heard in

a chapter 9 case are municipal employees, local residents, non-resident owners

of real property, special tax payers, securities firms, and local banks.

POWERS OF THE DEBTOR

Due to statutory limitations placed

upon the power of the court in a

municipal debt adjustment proceeding,

the court is far less involved in the conduct of a municipal bankruptcy case

(and in the operation of the municipal

entity) while the debtor’s financial

affairs are undergoing reorganization.

The debtor has broad powers to use its

property, raise taxes, and make expenditures as it sees fit. The debtor is also

permitted to adjust burdensome nondebt contractual relationships under

the power to reject executory contracts

and unexpired leases, subject to court

approval. Municipalities may also

reject collective bargaining agreements

and retiree benefit plans without going

through the usual procedures required

in chapter 11 cases. The municipality

also has the authority to borrow money

during a chapter 9 case as an administrative expense. 11 U.S.C. §§ 364,

901(a). This ability is important to the

survival of a municipality that has

exhausted all other resources. A chapter 9 municipality has the same power
50 • MUNICIPALITY BANKRUPTCY

to obtain credit as it does outside of

bankruptcy. The court does not have

supervisory authority over the amount

of debt the municipality incurs in its

operation. The municipality also has

the same avoiding powers as other

debtors, may employ professionals

without court approval, and fees are

reviewed only within the context of

plan confirmation.

DISMISSAL

As noted above, if an objection is filed,

the court may dismiss the petition after

notice and a hearing if the debtor did

not file the petition in good faith or if

the petition does not meet the requirements of chapter 9. 11 U.S.C. § 921(c).

A chapter 9 case may also be dismissed,

after notice and a hearing, for cause,

including lack of prosecution, unreasonable delay by the debtor that is prejudicial to creditors, failure to propose a

plan within the time fixed by the court,

nonacceptance of a plan within the time

fixed by the court, denial of plan confirmation and denial of additional time for

filing another plan, material default by

the debtor under a confirmed plan, or

termination of a confirmed plan by reason of the occurrence of a condition

specified in the plan. 11 U.S.C. § 930.

TREATMENT OF

BONDHOLDERS AND

OTHER LENDERS

Different types of bonds receive different treatment in municipal bankruptcy

cases. General obligation bonds are

treated as general debt in the chapter 9

case. The municipality is not required

to make payments of either principal or

interest on account of such bonds during the case. The obligations created by

general obligation bonds are subject to

negotiation and possible restructuring

under the plan of adjustment.

Special revenue bonds, by contrast,

will continue to be secured and serviced

during the pendency of the chapter 9

case through continuing application and

payment of ongoing special revenues.

11 U.S.C. § 928. Holders of special revenue bonds can expect to receive payment on such bonds during the chapter 9

case if special revenues are available. The

application of pledged special revenues

to indebtedness secured by such revenues

is not stayed as long as the pledge is

consistent with section 928 [§ 922(d)

erroneously refers to § 927 rather than

§ 928] of the Code, which insures that a

lien of special revenues is subordinate to

the operating expenses of the project or

system from which the revenues are

derived. 11 U.S.C. § 922(d).

Bondholders generally do not have to

worry about the threat of preference liability with respect to any prepetition

payments on account of bonds or notes,

whether special revenue or general

obligations. Any transfer of the municipal debtor’s property to a noteholder or

bondholder on account of a note or

bond cannot be avoided as a preference,

i.e., as an unauthorized payment to a

creditor made while the debtor was

insolvent. 11 U.S.C. § 926(b).

PLAN FOR ADJUSTMENT

OF DEBTS

The Bankruptcy Code provides that the

debtor shall file a plan. 11 U.S.C.

§ 941. The plan must be filed with the

petition or at such later time as the

court fixes. There is no provision in

chapter 9 allowing creditors or other

parties in interest to file a plan. This

limitation is required by the Supreme

Court’s pronouncements in Ashton,
MUNICIPALITY BANKRUPTCY • 51

298 U.S. at 513, and Bekins, 304 U.S.

at 27, which interpreted the Tenth

Amendment as requiring that a municipality be left in control of its governmental affairs during a chapter 9 case.

Neither creditors nor the court may

control the affairs of a municipality

indirectly through the mechanism of

proposing a plan of adjustment of the

municipality’s debts that would in

effect determine the municipality’s

future tax and spending decisions.

CONFIRMATION

STANDARDS

The standards for plan confirmation in

chapter 9 cases are a combination of the

statutory requirements of 11 U.S.C.

§ 943(b) and those portions of 11 U.S.C.

§ 1129 (the chapter 11 confirmation

standards) that are made applicable by

11 U.S.C. § 901(a). Section 943(b) lists

seven general conditions to confirmation

of a plan. The court must confirm a plan

if the following conditions are met:

1. the plan complies with the provisions

of title 11 made applicable by sections

103(e) and 901;

2. the plan complies with the provisions

of chapter 9;

3. all amounts to be paid by the debtor

or by any person for services or expenses in the case or incident to the plan have

been fully disclosed and are reasonable;

4. the debtor is not prohibited by law

from taking any action necessary to

carry out the plan;

5. except to the extent that the holder of

a particular claim has agreed to a different treatment of such claim, the plan

provides that on the effective date of the

plan each holder of a claim of a kind

specified in section 507(a)(1) will receive

on account of such claim cash equal to

the allowed amount of such claim;

6. any regulatory or electoral approval

necessary under applicable nonbankruptcy law in order to carry out any

provision of the plan has been obtained, or such provision is expressly

conditioned on such approval; and

7. the plan is in the best interests of

creditors and is feasible.

11 U.S.C. § 943(b).

Section 943(b)(1) requires as a condition to confirmation that the plan comply with the provisions of the

Bankruptcy Code made applicable by

sections 103(e) and 901(a) of the Code.

The most important of these for purposes of confirming a plan are those provisions of section 1129 of the Code

(1129(a)(2), (a)(3), (a)(6), (a)(8), (a)(10))

that are made applicable by section

901(a). Section 1129(a)(8) requires as a

condition to confirmation that the plan

has been accepted by each class of

claims or interests that is impaired under

the plan. Therefore, if the plan proposes

treatment for a class of creditors such

that the class is impaired (the creditor’s

legal, equitable, or contractual rights are

altered), then that class’s acceptance is

required. If the class is not impaired,

then acceptance by that class is not

required as a condition to confirmation.

Under section 1129(a)(10), the court

may confirm the plan only if, should any

class of claims be impaired under the

plan, at least one impaired class has

accepted the plan. Even if no impaired
52 • MUNICIPALITY BANKRUPTCY

classes of creditors consent to the plan,

plan confirmation is still possible under

the “cram down” provisions of section

1129(b). Under “cram down,” if all

other requirements are met except the

section 1129(a)(8) requirement that all

classes either be unimpaired or have

accepted the plan, then the plan is confirmable if it does not discriminate

unfairly and is fair and equitable.

The requirement that the plan be in

the “best interests of creditors” means

something different in chapter 9 than

under chapter 11. Under chapter 11, a

plan is said to be in the “best interests

of creditors” if creditors would receive

as much under the plan as they would

if the debtor were liquidated. 11 U.S.C.

§ 1129(a)(7)(A)(ii). Obviously, a different interpretation is needed in chapter 9

cases because a municipality’s assets

cannot be liquidated to pay creditors.

In the chapter 9 context, the “best

interests of creditors” test has generally

been interpreted to mean that the plan

must be better than other alternatives

available to the creditors. See 4 Collier

on Bankruptcy ¶ 943.03[7] (15th ed.

1994). Generally speaking, the alternative to chapter 9 is dismissal of the case,

permitting every creditor to fend for

itself. An interpretation of the best

interests of creditors test to require that

the municipality devote all resources

available to the repayment of creditors

would appear to exceed the standard.

The courts generally apply the test to

require a reasonable effort by the

municipal debtor that is a better alternative for its creditors than dismissal of

the case. Id.

A special tax payer affected by the

plan may object to confirmation of the

plan. 11 U.S.C. § 943(a). Other parties

in interest may also object to confirmation, including creditors whose claims

are affected by the plan, an organization

of employees of the debtor, and other

tax payers, as well as the Securities

and Exchange Commission. 11 U.S.C.

§§ 1109(a), 1128(b), 901(a).

DISCHARGE

A municipal debtor receives a discharge

in a chapter 9 case after (1) confirmation of the plan, (2) deposit by the

debtor of any consideration to be distributed under the plan with the disbursing agent appointed by the court,

and (3) a determination by the court

that securities deposited with the disbursing agent will constitute valid legal

obligations of the debtor and that

any provision made to pay or secure

payment of such obligations is valid.

11 U.S.C. § 944(b). Thus, the discharge

is conditioned not only upon confirmation, but also upon deposit of the consideration to be distributed under the

plan and a court determination of the

validity of securities to be issued.

There are two exceptions to the discharge in chapter 9 cases. The first is

for any debt excepted from discharge

by the plan or order confirming the

plan. The second exception is for a debt

owed to an entity that, before confirmation of the plan, had neither notice

nor actual knowledge of the case.

11 U.S.C. § 944(c).

At any time within 180 days after

entry of the confirmation order, the

court may, after notice and a hearing,

revoke the order of confirmation if the

order was procured by fraud. 11 U.S.C.

§§ 901(a) and 1144.

The court may retain jurisdiction over

the case for such period of time as is necessary for the successful implementation

of the plan. 11 U.S.C. § 945(a).
OVERVIEW

Typically, when a brokerage firm fails,

the SIPC will arrange to have the failed

brokerage’s accounts transferred to a

different securities brokerage firm. If

the SIPC is unable to arrange the

accounts’ transfer, the failed firm is liquidated. In that case, the SIPC will send

investors either certificates for the stock

that was lost or a check for the market

value of the shares.

Although the Bankruptcy Code provides for a stockbroker liquidation proceeding, 11 U.S.C. § 741 et seq., it is

far more likely that a failing brokerage

will find itself involved in a SIPA proceeding rather than a Bankruptcy Code

liquidation case. Brokerage firms may

be liquidated under the Bankruptcy

Code, however, if SIPC does not file an

application for a protective decree with

the district court or if the district court

finds that customers of the brokerage

firm are not in need of protection under

SIPA. 15 U.S.C. §§ 78eee.

HISTORY

Prior to 1938, little protection existed

for customers of a bankrupt stockbroker

unless they could trace cash and securities held by failed stockbrokers. In 1938

Congress enacted section 60e of the

Bankruptcy Act and created a single and

separate fund concept which was intended to minimize losses to customers by

giving them priority over claims of genSecurities

Investor

Protection Act

Since being established by

Congress in 1970, the

Securities Investor Protection

Corporation has protected

investors who leave stocks,

bonds, other securities and

cash with brokerage firms by

ensuring that every customer

gets back what he or she left

with the firm—up to $500,000

per customer, including no

more than $100,000 cash. The

sole function of SIPC is to

return to investors securities

and cash left with failed brokerages. It does not protect

investors against losses in the

securities markets.

SIPA
54 • SECURITIES INVESTOR PROTECTION ACT

eral creditors. 1898 Bankruptcy Act §

60(e)(2) (repealed). Because the fund

was normally inadequate, however, customer losses continued.

Following a period of great expansion in the securities industry during

the 1960’s, a serious business contraction hit the industry in 1969–1970.

This situation led to voluntary liquidations, mergers, receiverships, and bankruptcies of a substantial number of brokerage houses. Annotation, Validity,

Construction, and Application of

Securities Investor Protection Act of

1970 (15 U.S.C.S. §§ 78aaa et seq.), 23

A.L.R. Fed. 157, 179 (1975). Customers of these firms found the cash

and securities which they had on

deposit dissipated or tied up in lengthy

bankruptcy proceedings. Along with

the concern over mounting customer

losses and the subsequent erosion of

investor confidence, the Congress was

also concerned with a possible “domino effect” involving otherwise solvent

brokers that had substantial open

transactions with firms that failed. In

reaction to this growing concern, the

Congress enacted the Securities

Investor Protection Act of 1970 (hereinafter referred to as SIPA). The goal

was to arrest this process, restore

investor confidence in the capital markets, and upgrade the financial responsibility requirements for registered brokers and dealers. Securities Investor

Protection Corp. v. Barbour, 421 U.S.

412, 414 (1975). SIPA was designed to

apportion responsibility for carrying

out the various goals of the legislation

to several groups. Among them are the

Securities and Exchange Commission

(hereinafter referred to as SEC), various

securities industry self-regulatory organizations, and the Securities Investor

Protection Corporation (hereinafter

referred to as SIPC). SIPA was designed

to create a new form of liquidation

proceeding. It is applicable only to

member firms and was designed to

accomplish the completion of open

transactions and the speedy return of

most customer property. Id.

SIPA

SIPA is codified as Title 15, United

States Code, Sections 78aaa–111. SIPA

created SIPC, a nonprofit, private membership corporation to which most registered brokers and dealers are required

to belong. 15 U.S.C. § 78ccc. The SIPC

fund, which constitutes an insurance

program, is authorized under 15 U.S.C.

§ 78ddd(a) and assessments against

members are authorized by 15 U.S.C.

§§ 78ddd(c) and (d). The fund is

designed to protect the customers of

brokers or dealers subject to SIPA from

loss in case of financial failure of the

member. The fund is supported by

assessments upon its members. If the

fund should become inadequate, SIPA

authorizes borrowing against the U.S.

Treasury. An analogy could be made to

the role of the Federal Deposit Insurance

Corporation in the banking industry.

BANKRUPTCY

LIQUIDATION VERSUS

SIPA LIQUIDATION IN

BANKRUPTCY COURT

The essential difference between a

liquidation under the Bankruptcy Code

(11 U.S.C. §§ 741–752) and one under

SIPA is that under the Code the trustee

is charged with converting securities to

cash as quickly as possible and, with

the exception of the delivery of customer name securities, making cash distributions to customers of the debtor in
SECURITIES INVESTOR PROTECTION ACT • 55

satisfaction of their claims. A SIPC

trustee, on the other hand, is required to

distribute securities to customers to the

greatest extent practicable in satisfaction of their claims against the debtor. 

There is a fundamental difference in

orientation between the two proceedings. There is a statutory grant of

authority to a SIPC trustee to purchase

securities to satisfy customer net equity

claims to specified securities. 15 U.S.C.

§ 78fff–2(d). The trustee is required

to return customer name securities

to customers of the debtor (15 U.S.C.

§ 78fff–2)(c)(2)), distribute the fund of

“customer property” ratably to customers (15 U.S.C. § 78fff–2(b)), and

pay, with money from the SIPC fund,

remaining customer net equity claims,

to the extent provided by the Act

(15 U.S.C. §§ 78fff–2(b) and 3(a)). A

trustee operating under the Code lacks

similar resources. The Code seeks to

protect the filing date value of a customer’s securities account by liquidating all non-customer name securities.

SIPA seeks to preserve an investor’s

portfolio as it stood on the filing date.

Under SIPA, the customer will receive

securities whenever possible.

ROLE OF THE

DISTRICT COURT

15 U.S.C. § 78eee(a)(3)(A) provides

that SIPC may file an application for a

protective decree with the United States

district court if SIPC determines that

any member has failed or is in danger

of failing to meet obligations to

customers and meets one of the four

conditions specified in 15 U.S.C.

§ 78eee(b)(1). This application will be

filed as a civil case in which SIPC or the

SEC or both are named as plaintiff, and

the member securities firm is named as

the debtor-defendant. In the event that

the SIPC refuses to act under the SIPA,

the SEC may apply to the United States

District Court for the District of

Columbia to require the SIPC to discharge its obligations under SIPA.

15 U.S.C. § 78ggg(b). By contrast, customers of failing broker-dealers do not

have an implied right of action under

SIPA to compel the SIPC to exercise its

statutory authority for their benefit.

Barbour at 425. Upon the filing of an

application, the district court has exclusive jurisdiction of the debtor-defendant and its property.

The institution of a case under SIPA

brings a pending bankruptcy liquidation

to a halt. Irrespective of the automatic

stay, SIPC may file an application for a

protective decree under SIPA. 11 U.S.C.

§ 742; 15 U.S.C. § 78aaa et seq. The filing stays all proceedings in the bankruptcy case until the SIPC action is completed. Id. Pending issuance of a protective decree, the district court:

[i.] shall stay any pending bankruptcy,

mortgage foreclosure, equity receivership, or other proceeding to reorganize,

conserve, or liquidate the debtor or its

property and any other suit against any

receiver, conservator, or trustee of the

debtor or its property, and shall continue such stay upon appointment of a

trustee ...

[ii.] may stay any proceeding to enforce

a lien against property of the debtor or

any other suit against the debtor,

including a suit by stockholders of the

debtor which interferes with prosecution by the trustee of claims against former directors, officers, or employees of

the debtor, and may continue such stay

upon appointment of a trustee ...
56 • SECURITIES INVESTOR PROTECTION ACT

[iii.] may stay enforcement of, and

upon appointment of a trustee ... [if a

protective decree is issued] ... may continue the stay for such period of time as

may be appropriate, but shall not abrogate,[sic] any right of setoff, except to

the extent such right may be affected

under section 553 of Title 11 of the

United States Code ... and shall not

abrogate the right to enforce a valid,

nonpreferential lien or pledge against

the property of the debtor; and

[iv.] may appoint a temporary receiver.

15 U.S.C. § 78eee(b)(2)(B)(I–iv) (emphasis added).

In addition, upon the filing of a SIPC

application, 11 U.S.C. § 362 comes

into effect.

SIPA provides that the district court

shall issue a protective decree if the

debtor consents, the debtor fails to

contest the application for a protective decree, or the district court finds

that one of the conditions specified in

15 U.S.C. § 78eee(b)(1) exist. If the

court issues a protective decree, then

the court will appoint a trustee and an

attorney for the trustee whom SIPC, in

its sole discretion, specifies. 15 U.S.C.

§ 78eee(b)(3). Upon the issuance of a

protective decree and appointment of a

trustee, or a trustee and counsel, the

district court shall order the removal of

the entire liquidation proceeding to the

bankruptcy court in the same judicial

district. 15 U.S.C. § 78eee(b)(4).

REMOVAL TO

BANKRUPTCY COURT

The case is removed to the bankruptcy

court as an adversary proceeding for

liquidation. No filing or removal fee is

charged. The reason for using an adversary proceeding number is historical.

While these SIPA proceedings are not

bankruptcy cases, by law certain procedures prescribed in chapters 1, 3, and 5,

and subchapters I and II of chapter 7 of

Title 11 of the United States Code are

applicable in SIPA proceedings. In addition, there is no related bankruptcy case

number. Statistical reports to the

Administrative Office should repeat the

adversary number so that the Statistics

Division will know it is a SIPA matter.

Forms B111A (Adversary Proceeding

Opening Report) and B111B (Adversary Proceeding Closing Report) should

be used since this is an adversary proceeding. For adversary proceedings

within the adversary SIPA proceeding,

the clerk’s office should use the original

adversary proceeding number for the

related case number.

SIPA requires that the bankruptcy

court hold a hearing with 10 days

notice to customers, creditors, and

stockholders on the disinterestedness of

the trustee or attorney for the trustee.

15 U.S.C. § 78eee(b)(6)(B). At the hearing, the court will entertain grounds for

objection to the retention of the trustee

or attorney for the trustee including,

among other things, insider considerations. 15 U.S.C. § 78eee(b)(6)(A). If

SIPC appoints itself as trustee, it should

be deemed disinterested, and where a

SIPC employee has been specified, the

employee shall not be disqualified solely because of his employment. Id.

Neither the Bankruptcy Code, Bankruptcy Rules, nor SIPA provide for

United States trustee or Bankruptcy

Administrator involvement.

SIPA provides for noticing of both

customers and creditors. The noticing

requirements provided for in 15 U.S.C.
SECURITIES INVESTOR PROTECTION ACT • 57

§ 78fff–2(a)(1) are performed by the

trustee, not the clerk of the bankruptcy

court. While SIPA does not require a

formal proof of claim for customers

(other than certain insiders and their relatives), it does require a written statement of claim. The trustee will normally provide customers with claim forms

and instructions. The claim form must

be filed with the trustee rather than the

clerk of the bankruptcy court. 15 U.S.C.

§ 78fff2(a)(2). With limited, specified

exceptions, no claim of a customer or

other creditor can be allowed unless it is

received by the trustee within six

months after the initial publication of

notice. 15 U.S.C. § 78fff–2(a)(3).

LIQUIDATION

PROCEEDINGS

The purposes of a SIPA liquidation are:

(1) to deliver customer name securities to

or on behalf of customers; (2) to distribute customer property and otherwise satisfy net equity claims of customers; (3) to

sell or transfer offices and other productive units of the debtor’s business; (4) to

enforce the rights of subrogation; and (5)

to liquidate the business as promptly as

possible. 15 U.S.C. § 78fff(a). To the

extent possible, consistent with SIPA, the

liquidation is conducted in accordance

with chapters 1, 3, 5 and subchapters I

and II of chapter 7 of Title 11. 15 U.S.C.

§ 78fff(b). A section 341 meeting of creditors is conducted by the trustee.

Noncustomer claims are handled as in an

asset case. Costs and expenses, and priorities of distribution from the estate, are

allowed as provided in section 726 of

Title 11. Funds advanced by SIPC to the

trustee for costs and expenses are

recouped from the estate, to the extent

there is any estate, pursuant to section

507 of Title 11.

POWERS OF THE TRUSTEE

The powers of the trustee in a SIPC

case are essentially the same as those

vested in a chapter 7 trustee appointed

under Title 11. “In addition, a trustee

The purposes of a

SIPA liquidation are:

(1) to deliver customer

name securities to or

on behalf of customers; (2) to distribute customer property

and otherwise satisfy

net equity claims of

customers; (3) to sell

or transfer offices and

other productive units

of the debtor’s business; (4) to enforce

the rights of subrogation; and (5) to liquidate the business as

promptly as possible.
58 • SECURITIES INVESTOR PROTECTION ACT

may, with the approval of SIPC but

without any need for court approval:

1. hire and fix the compensation of all

personnel (including officers and

employees of the debtor and of its

examining authority) and other persons

(including accountants) that are deemed

by the trustee necessary for all or any

purposes of the liquidation proceeding;

2. utilize SIPC employees for all or any

purposes of a liquidation proceeding; and

3. margin and maintain customer

accounts of the debtor ...”

15 U.S.C. § 78fff–1(a).

A SIPC trustee may reduce to money

customer securities constituting customer

property or in the general estate of the

debtor. 15 U.S.C. § 78fff–1(b). The

trustee shall, however, deliver securities

to customers to the maximum extent

practicable. 15 U.S.C. § 78fff–1(b)(1).

Subject to prior approval of SIPC, but

again without any need for court

approval, the trustee may also pay or

guarantee any part of the debtor’s

indebtedness to a bank, person, or other

lender when certain conditions exist.

15 U.S.C. § 78fff–1(b)(2).

The trustee is responsible for investigating the acts, conduct, and condition

of the debtor and reporting thereon to

the court. 15 U.S.C. § 78fff–1(d)(1). The

trustee must also provide a statement

on the investigation to SIPC and to other

persons as the court might direct.

15 U.S.C. § 78fff–1(d)(4). Moreover, the

trustee must make periodic reports to

the court and to SIPC on the progress of

distribution of cash and securities to customers. 15 U.S.C. § 78fff–1(c).

CLAIMS

Upon receipt of a written statement of

claim, the trustee promptly discharges

obligations of the debtor relating to

cash and securities by delivering securities or making payments to or on

behalf of the customer insofar as such

obligations are ascertainable from

books and records of the debtor, or are

otherwise established to the satisfaction of the trustee. The value of securities delivered in this regard are calculated as of the close of business on the

filing date. 15 U.S.C. § 78fff–2(b).

The court must authorize the trustee

to satisfy claims out of monies

advanced by SIPC for this purpose,

notwithstanding that the estate may

not have sufficient funds for such payment. 15 U.S.C. § 78fff–2(b)(1). The

court is generally not involved in the

process except to the extent that a dispute arises between the trustee and customers regarding specific claims.

Simple objections stay with the initial

adversary proceeding. Occasionally,

however, significant litigation arises in

this area which generates related

actions in the form of additional adversary proceedings.

DISTRIBUTION

Customer related property of the

debtor is allocated as follows:

A. First, to SIPC in repayment of

advances made to the extent they were

used to recover securities apportioned

to customer property;

B. Second, to customers of the debtor

on the basis of their net equities;

C. Third, to SIPC as subrogee for the

claims of customers; and
SECURITIES INVESTOR PROTECTION ACT • 59

D. Fourth, to SIPC in repayment of

advances made by SIPC to transfer or

sell customer accounts to another SIPC

member firm.

15 U.S.C. § 78fff–2(c)(1).

The trustee must deliver customer

name securities to the customer if such

customer is not indebted to the debtor.

If indebted, then the customer may,

with the approval of the trustee, reclaim

securities in his name upon payment

to the trustee of all such indebtedness.

15 U.S.C. § 78fff–2(c)(2).

The trustee may, with the approval

of SIPC, sell or otherwise transfer

to another member of SIPC, without

consent of any customer, all or any part

of the account of a customer. 15 U.S.C.

§ 78fff–2(f). The trustee may also enter

into any agreement, and SIPC will

advance funds as necessary, to indemnify the member firm against shortages

of cash or securities in customer

accounts sold or transferred. 15 U.S.C.

§ 78fff–2(f)(2). In addition, the trustee

may purchase securities in a fair and

orderly market in order to deliver securities to customers in satisfaction of

their claims. 15 U.S.C. § 78fff–2(d).

To the extent customer property and

SIPC advances are not sufficient to pay

or satisfy in full the net equity claims of

customers, then customers are entitled

to participate in the estate as unsecured

creditors. 15 U.S.C. § 78fff–2(c)(1).

ADVANCES

The law requires that SIPC make

advances to the trustee in order to satisfy claims and otherwise liquidate the

business. These advances are made to

satisfy customer claims in cash, to purchase securities to satisfy net equity

claims in lieu of cash, and to pay all necessary costs and expenses of administration and liquidation of the estate to the

extent the estate of the debtor is insufficient to pay said costs and expenses.

Any amount advanced in satisfaction of

customer claims may not exceed

$500,000 per customer. 15 U.S.C.

§ 78fff–3(a). If part of the claim is for

cash, the total amount advanced for

cash payment must not exceed

$100,000. 15 U.S.C. § 78fff–3(a)(1).

The difference between cash payments

and the maximum amount allowed can

be satisfied by the delivery of securities,

or cash in lieu of securities.

DIRECT PAYMENT UNDER

SIPA OUTSIDE THE

BANKRUPTCY COURT

In certain situations, SIPC may elect to

utilize a direct payment procedure to the

customers of a debtor, thereby avoiding a

trustee and the courts. Certain preconditions must exist. The claims of all customers must aggregate less than

$250,000, the debtor must be financially

distressed as defined in the law, and the

cost to SIPC for direct payment process

must be less than for liquidation through

the courts. 15 U.S.C. § 78fff–4(a).

If direct payment is utilized, the

entire proceeding remains outside the

court. The process remains essentially a

transaction between SIPC and the

debtor’s customers.

Although SIPA provides for a direct

payment procedure in lieu of instituting

a liquidation proceeding, the bankruptcy court may still become involved in

disputes regarding the direct payment

procedure. A person aggrieved by a

SIPC determination with respect to a

claim in a direct payment procedure

may, within six months following mail-
60 • SECURITIES INVESTOR PROTECTION ACT

ing of a SIPC determination, seek a final

adjudication of such claim by the court.

15 U.S.C. § 78fff–4(e). The courts having jurisdiction over cases under Title

11 have original and exclusive jurisdiction of any civil action for the adjudication of such claims. The action is to be

brought in the judicial district where the

head office of the debtor is located. It

would be brought as an adversary proceeding in the bankruptcy court even

though there is no main case.

ROLE OF SECURITIES AND

EXCHANGE COMMISSION

The SEC is responsible for regulating and

supervising the activities of the SIPC. The

SEC promulgates operating rules which

establish the role of self-regulatory organizations and examining authorities, and

their reporting responsibilities to SIPC of

inspections and reviews of its member

firms. SIPC’s member firms are also

required to provide information and documentation as necessary to assist in

accomplishing these inspections. The

penalties for fraud, deceit, or withholding 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 compensation 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 application which complies in form and content 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

required to fix a time for a hearing on

the application. Notice need not be

given to customers whose claims have

been or will be paid in full or creditors

who cannot reasonably be expected

to receive any distribution. 15 U.S.C.

§ 78eee(b)(5)(B).

SIPC will review the application and

file its recommendation with respect

to such allowances prior to the hearing on the application. In any case

where the allowances are to be paid by

SIPC without reasonable expectation

of recoupment and there is no difference between the amount applied for

and the amount recommended by

SIPC, the bankruptcy court must

award that amount. 15 U.S.C.

§ 78eee(b)(5)(C). If there is a difference, the court must, among other

considerations, place considerable

reliance on the recommendation of

SIPC. If the estate is insufficient to

cover these awards as costs of administration, 15 U.S.C. § 78eee(b)(5)(E)

provides that SIPC will advance the

necessary funds to cover the costs.
ADVERSARY PROCEEDING

A lawsuit arising in or related to a

bankruptcy case that is commenced by

filing a complaint with the bankruptcy

court.

ASSUME

An agreement to continue performing

duties under a contract or lease.

AUTOMATIC STAY

An injunction that automatically stops

lawsuits, foreclosure, garnishments,

and all collection activity against the

debtor the moment a bankruptcy petition is filed.

BANKRUPTCY 

A legal procedure for dealing with debt

problems of individuals and businesses;

specifically, a case filed under one of

the chapters of title 11 of the United

States Code (the Bankruptcy Code).

BANKRUPTCY 

ADMINISTRATOR 

An officer of the judiciary serving in the

judicial districts of Alabama and North

Carolina who, like the United States

trustee, is responsible for supervising

the administration of bankruptcy cases,

estates, and trustees, monitoring plans

and disclosure statements, monitoring

creditors’ committees, monitoring fee

applications, and performing other

statutory duties.

Bankruptcy

Terminology

Most debtors who file bankruptcy,

and many of their creditors, know

very little about the bankruptcy

process. The Public Information Series

of the Bankruptcy Judges Division is

designed to provide debtors, creditors, judiciary employees, and the

general public with a basic explanation of bankruptcy and how it works.

The series features eight pamphlets

that discuss chapter 7 (liquidation),

chapter 13 (adjustment of debts of

an individual with regular income),

chapter 12 (adjustment of debts of a

family farmer), chapter 11 (reorganization), chapter 9 (adjustment of

debts of a municipality), SIPA (the

Securities Investor Protection Act),

the bankruptcy discharge, and bankruptcy terminology. This pamphlet on

bankruptcy terminology explains, in

layman’s terms, many of the legal

terms that are used in cases filed

under the Bankruptcy Code.

TERMS

LIST OF
62 • BANKRUPTCY TERMINOLOGY

BANKRUPTCY CODE

The informal name for title 11 of the

United States Code (11 U.S.C. §§ 101–

1330), the federal bankruptcy law.

BANKRUPTCY COURT

The bankruptcy judges in regular active

service in each district; a unit of the district court.

BANKRUPTCY ESTATE 

All legal or equitable interests of the

debtor in property at the time of the

bankruptcy filing. (The estate includes

all property in which the debtor has an

interest, even if it is owned or held by

another person.)

BANKRUPTCY JUDGE

A judicial officer of the United States

district court who is the court official

with decision-making power over federal bankruptcy cases.

BANKRUPTCY MILL

A business not authorized to practice

law that provides bankruptcy counseling and prepares bankruptcy petitions.

BANKRUPTCY PETITION

A formal request for the protection of

the federal bankruptcy laws. (There is

an official form for bankruptcy petitions.)

BANKRUPTCY TRUSTEE

A private individual or corporation

appointed in all chapter 7, chapter 12,

and chapter 13 cases to represent the

interests of the bankruptcy estate and

the debtor’s creditors.

BUSINESS BANKRUPTCY

A bankruptcy case in which the debtor

is a business or an individual involved

in business and the debts are for business purposes.

CHAPTER 7

The chapter of the Bankruptcy Code

providing for “liquidation,” i.e., the

sale of a debtor’s nonexempt property

and the distribution of the proceeds to

creditors.

CHAPTER 7 TRUSTEE

A person appointed in a chapter 7 case

to represent the interests of the bankruptcy estate and the unsecured creditors. (The trustee’s responsibilities

include reviewing the debtor’s petition

and schedules, liquidating the property of the estate, and making distributions to creditors. The trustee may

also bring actions against creditors or

the debtor to recover property of the

bankruptcy estate.)

CHAPTER 11

A reorganization bankruptcy, usually

involving a corporation or partnership.

(A chapter 11 debtor usually proposes

a plan of reorganization to keep its

business alive and pay creditors over

time. People in business or individuals

can also seek relief in chapter 11.)

CHAPTER 12

The chapter of the Bankruptcy Code

providing for adjustment of debts of a

“family farmer,” as that term is defined

in the Bankruptcy Code.

CHAPTER 13

The chapter of the Bankruptcy Code

providing for adjustment of debts of

an individual with regular income.

(Chapter 13 allows a debtor to keep

property and pay debts over time, usually three to five years.)
BANKRUPTCY TERMINOLOGY • 63

CHAPTER 13 TRUSTEE

A person appointed to administer a

chapter 13 case. (A chapter 13 trustee’s

responsibilities are similar to those of a

chapter 7 trustee; however, a chapter

13 trustee has the additional responsibilities of overseeing the debtor’s plan,

receiving payments from debtors, and

disbursing plan payments to creditors.)

CLAIM 

A creditor’s assertion of a right to payment from a debtor or the debtor’s

property.

COMPLAINT 

The first or initiatory document in a

lawsuit that notifies the court and the

defendant of the grounds claimed by

the plaintiff for an award of money or

other relief against the defendant.

CONFIRMATION 

Approval of a plan of reorganization by

a bankruptcy judge.

CONSUMER BANKRUPTCY

A bankruptcy case filed to reduce or

eliminate debts that are primarily consumer debts.

CONSUMER DEBTS

Debts incurred for personal, as opposed

to business, needs.

CONTINGENT CLAIM

A claim that may be owed by the debtor

under certain circumstances, for example,

where the debtor is a cosigner on another

person’s loan and that person fails to pay.

CREDITOR 

A person to whom or business to which

the debtor owes money or that claims

to be owed money by the debtor.

DEBTOR 

A person who has filed a petition for

relief under the bankruptcy laws.

DEFENDANT 

An individual (or business) against

whom a lawsuit is filed.

DISCHARGE 

A release of a debtor from personal liability for certain dischargeable debts.

(A discharge releases a debtor from personal liability for certain debts known

as dischargeable debts (defined below)

and prevents the creditors owed those

debts from taking any action against

the debtor or the debtor’s property to

collect the debts. The discharge also

prohibits creditors from communicating with the debtor regarding the debt,

including telephone calls, letters, and

personal contact.)

DISCHARGEABLE DEBT

A debt for which the Bankruptcy Code

allows the debtor’s personal liability to

be eliminated.

DISCLOSURE STATEMENT

A written document prepared by the

chapter 11 debtor or other plan proponent that is designed to provide “adequate information” to creditors to

enable them to evaluate the chapter 11

plan of reorganization.

EQUITY 

The value of a debtor’s interest in property that remains after liens and other

creditors’ interests are considered.

(Example: If a house valued at $60,000

is subject to a $30,000 mortgage, there

is $30,000 of equity.)
64 • BANKRUPTCY TERMINOLOGY

EXECUTORY CONTRACT

OR LEASE

Generally includes contracts or leases

under which both parties to the agreement have duties remaining to be performed. (If a contract or lease is executory, a debtor may assume it or reject it.)

EXEMPT 

A description of any property that a

debtor may prevent creditors from

recovering.

EXEMPTION

Property that the Bankruptcy Code or

applicable state law permits a debtor to

keep from creditors.

EXEMPT PROPERTY

Property or value in property that a

debtor is allowed to retain, free from

the claims of creditors who do not

have liens.

FACE SHEET FILING

A bankruptcy case filed either without

schedules or with incomplete schedules listing few creditors and debts.

(Face sheet filings are often made for

the purpose of delaying an eviction or

foreclosure.)

FAMILY FARMER

An individual, individual and spouse,

corporation, or partnership engaged in

a farming operation who meet certain

debt limits and other statutory criteria

for filing a petition under chapter 12.

FRAUDULENT TRANSFER

A transfer of a debtor’s property made

with intent to defraud or for which the

debtor receives less than the transferred

property’s value.

FRESH START

The characterization of a debtor’s status

after bankruptcy, i.e., free of most debts.

(Giving debtors a fresh start is one purpose of the Bankruptcy Code.)

INSIDER (of individual debtor)

Any relative of the debtor or of a general partner of the debtor; partnership in

which the debtor is a general partner;

general partner of the debtor; or corporation of which the debtor is a director,

officer, or person in control.

INSIDER (of corporate debtor)

A director, officer, or person in control

of the debtor; a partnership in which the

debtor is a general partner; a general

partner of the debtor; or a relative of a

general partner, director, officer, or person in control of the debtor.

JOINT ADMINISTRATION 

A court-approved mechanism under

which two or more cases can be administered together. (Assuming no conflicts

of interest, these separate firms or individuals can pool their resources, hire the

same professionals, etc.)

JOINT PETITION

One bankruptcy petition filed by a husband and wife together.

LIEN 

A charge upon specific property designed to secure payment of a debt or performance of an obligation.

LIQUIDATION 

A sale of a debtor’s property with the

proceeds to be used for the benefit of

creditors.
BANKRUPTCY TERMINOLOGY • 65

LIQUIDATED CLAIM

A creditor’s claim for a fixed amount of

money.

MOTION TO LIFT

THE AUTOMATIC STAY

A request by a creditor to allow the

creditor to take an action against a

debtor or the debtor’s property that

would otherwise be prohibited by the

automatic stay.

NO-ASSET CASE

A chapter 7 case where there are no

assets available to satisfy any portion of

the creditors’ unsecured claims.

NONDISCHARGEABLE

DEBT

A debt that cannot be eliminated in

bankruptcy.

OBJECTION TO DISCHARGE

A trustee’s or creditor’s objection to the

debtor’s being released from personal

liability for certain dischargeable debts.

OBJECTION TO

EXEMPTIONS

A trustee’s or creditor’s objection to a

debtor’s attempt to claim certain property as exempt, i.e., not liable for any

prepetition debt of the debtor.

PARTY IN INTEREST

A party who is actually and substantially interested in the subject matter, as

distinguished from one who has only a

nominal on technical interest in it.

PLAN

A debtor’s detailed description of how

the debtor proposes to pay creditors’

claims over a fixed period of time.

PLAINTIFF

A person or business that files a formal

complaint with the court.

POSTPETITION TRANSFER

A transfer of a debtor’s property made

after the commencement of the case.

PREBANKRUPTCY

PLANNING

The arrangement (or rearrangement) of

a debtor’s property to allow the debtor

to take maximum advantage of exemptions. (Prebankruptcy planning typically includes converting nonexempt

assets into exempt assets.)

PREFERENTIAL DEBT

PAYMENT

A debt payment made to a creditor in

the 90-day period before a debtor files

bankruptcy (or within one year if the

creditor was an insider) that gives the

creditor more than the creditor would

receive in the debtor’s chapter 7 case.

PRIORITY

The Bankruptcy Code’s statutory ranking of unsecured claims that determines

the order in which unsecured claims will

be paid if there is not enough money to

pay all unsecured claims in full.

PRIORITY CLAIM

An unsecured claim that is entitled to be

paid ahead of other unsecured claims

that are not entitled to priority status.

Priority refers to the order in which

these unsecured claims are to be paid.

PROOF OF CLAIM

A written statement describing the

reason a debtor owes a creditor

money. (There is an official form for

this purpose.)
66 • BANKRUPTCY TERMINOLOGY

PROPERTY OF THE ESTATE

All legal or equitable interests of the

debtor in property as of the commencement of the case.

REAFFIRMATION

AGREEMENT

An agreement by a chapter 7 debtor to

continue paying a dischargeable debt

after the bankruptcy, usually for the

purpose of keeping collateral or mortgaged property that would otherwise be

subject to repossession.

SECURED CREDITOR

An individual or business holding a

claim against the debtor that is secured

by a lien on property of the estate or

that is subject to a right of setoff.

SECURED DEBT

Debt backed by a mortgage, pledge of

collateral, or other lien; debt for

which the creditor has the right to

pursue specific pledged property upon

default.

SCHEDULES

Lists submitted by the debtor along

with the petition (or shortly thereafter)

showing the debtor’s assets, liabilities,

and other financial information. (There

are official forms a debtor must use.)

STATEMENT OF

FINANCIAL AFFAIRS

A series of questions the debtor must

answer in writing concerning sources of

income, transfers of property, lawsuits

by creditors, etc. (There is an official

form a debtor must use.)

STATEMENT OF INTENTION

A declaration made by a chapter 7

debtor concerning plans for dealing

with consumer debts that are secured

by property of the estate.

SUBSTANTIAL ABUSE

The characterization of a bankruptcy

case filed by an individual whose debts

are primarily consumer debts where the

court finds that the granting of relief

would be an abuse of chapter 7

because, for example, the debtor can

pay its debts.

SUBSTANTIVE

CONSOLIDATION

Putting the assets and liabilities of two

or more related debtors into a single

pool to pay creditors. (Courts are reluctant to allow substantive consolidation

since the action must not only justify

the benefit that one set of creditors

receives, but also the harm that other

creditors suffer as a result.)

341 MEETING

A meeting of creditors at which the

debtor is questioned under oath by

creditors, a trustee, examiner, or the

United States trustee about his/her

financial affairs.

TRANSFER

Any mode or means by which a

debtor disposes of or parts with

his/her property.

TRUSTEE

The representative of the bankruptcy

estate who exercises statutory powers,

principally for the benefit of the unsecured creditors, under the general

supervision of the court and the direct

supervision of the United States trustee

or Bankruptcy Administrator.
BANKRUPTCY TERMINOLOGY • 67

TYPING SERVICE

A business not authorized to practice

law that prepares bankruptcy petitions.

UNITED STATES TRUSTEE

An officer of the Justice Department

responsible for supervising the administration of bankruptcy cases, estates,

and trustees, monitoring plans and

disclosure statements, monitoring

creditors’ committees, monitoring fee

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 nonpayment 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.

VOLUNTARY TRANSFER

A transfer of a debtor’s property with

the debtor’s consent.

SOURCES

Doran, Personal Bankruptcy and Debt

Adjustment, 135–139 (1991)

Griffin, Personal Bankruptcy: What

You Should Know, 145–149 (1994)
Administrative Office of the United States Courts

Thurgood Marshall Federal Judiciary Building

Washington, D.C. 20544

PHONE: (202) 502-1900