Bankruptcy Basics: A Primer
Released: 2018-03-22T00:00:00

Summary:
U.S. bankruptcy law has two central aims. First, bankruptcy law seeks to relieve debtors of certain obligations they are unable to repay by providing them with a "fresh start" from financial difficulties. At the same time, bankruptcy law attempts to preserve the countervailing interests of creditors and other stakeholders by maximizing total creditor return in an orderly and efficient fashion. Congress and the courts have established a complex system of statutes, procedural rules, and judicial precedents intended to balance these competing interests.
Various types of debtors—from individual consumers with modest incomes to the largest multinational corporations—may potentially encounter difficulty repaying their debts. To accommodate the differing needs of such debtors, the Bankruptcy Code—which is the primary source of bankruptcy law in the United States—contains a variety of "Chapters" which create several different forms of bankruptcy proceedings. Although the end goal of each of those proceedings is to balance the conflicting interests of debtors, creditors, and other stakeholders, each Chapter has its own procedures, eligibility requirements, and forms of relief. Whereas some Chapters aim to liquidate the debtor, others attempt to reorganize the debtor so that it may continue to operate as a going concern, while still others adjust the debtor's debts.
This report serves as a primer for Members and their staffs on the basics of U.S. bankruptcy law. The report provides a brief overview of the most essential concepts necessary for an informed understanding of the U.S. bankruptcy system, including
the competing policies underlying the Bankruptcy Code; the sources of bankruptcy law; the organization of the Bankruptcy Code; the key players in a bankruptcy proceeding; the initiation of a bankruptcy case; the "automatic stay" of creditor actions against the debtor; the various types of proceedings established by different Chapters of the Bankruptcy Code, as well as the differences between those proceedings; and the "discharge" of debt.

paragraphs: T he U.S. Constitution grants Congress the authority "to establish . . . uniform Laws on the subject of Bankruptcies throughout the United States." Pursuant to that authority, Congress has enacted a statute called the " Bankruptcy Code " which, along with other sources of law, governs bankruptcies in the United States. The Bankruptcy Code generally attempts to balance two competing policy concerns. On the one hand, bankruptcy aims to give honest debtors a "fresh start"—that is, to grant debtors relief from certain debts they cannot repay—so that they may "reorder their affairs, make peace with their creditors, and enjoy 'a new opportunity in life with a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.'" This fresh start generally comes in the form of a " discharge " of many forms of the debtor's debts, which consists of "a legal right not to pay" the discharged debts as well as "safeguards against harassment by the creditor" whose debt is discharged. At the same time, however, the bankruptcy system also attempts to maximize total creditor return by distributing a subset of the debtor's assets or income to creditors in an orderly, equitable, and efficient fashion. Thus, "Congress and the judiciary are constantly striving to achieve a wise balance between" offering "a fresh start for debtors" and ensuring "fairness to creditors." To that end, Congress has frequently amended the Bankruptcy Code since its initial enactment in 1978 in an attempt to recalibrate that balance.
Because recent estimates indicate that "over a million people file bankruptcy every year," bankruptcy law is vitally important to Congress and the nation as a whole. This report accordingly provides a primer for Members and their staffs on the basics of U.S. bankruptcy law. In so doing, the report provides a broad overview of the most essential concepts necessary for an informed understanding of the U.S. bankruptcy system, including
the competing policies underlying the Bankruptcy Code; the sources of bankruptcy law; the organization of the Bankruptcy Code; the key players in a bankruptcy proceeding; the initiation of a bankruptcy case; the "automatic stay" of creditor actions against the debtor; the various types of proceedings established by different "Chapters" of the Bankruptcy Code, as well as the differences between those proceedings; and the discharge of debt.
subsections: section_title: The Bankruptcy Code and Other Sources of Bankruptcy Law
paragraphs: As noted above, the Bankruptcy Code is the primary source of bankruptcy law in the United States. The Bankruptcy Code is codified at Title 11 of the United States Code and is divided into nine distinct "Chapters." The first three Chapters—Chapter 1 (General Provisions), Chapter 3 (Case Administration), and Chapter 5 (Creditors, the Debtor, and the Estate) —contain provisions that are generally applicable to most bankruptcy cases. The remaining Chapters, which this report discusses below, create different types of bankruptcy proceedings for different types of debtors.
The Bankruptcy Code is not, however, the only source of U.S. bankruptcy law. For one, the Federal Rules of Bankruptcy Procedure, which are "rules promulgated by the U.S. Supreme Court (on the recommendation of the U.S. Judicial Conference and its committees, and with the consent of Congress)," "provide a substantial set of procedural rules" that govern bankruptcy proceedings in the United States. Many courts have supplemented the Federal Rules of Bankruptcy Procedure by promulgating their own local procedural rules and orders that govern bankruptcy cases in their respective districts. The Judicial Conference of the United States has also promulgated official bankruptcy forms that litigants must use as templates when filing certain kinds of documents in a bankruptcy case.
Other federal laws can impact bankruptcy cases as well. For example, both the U.S. Code and the U.S. Constitution restrict the types of issues that a bankruptcy judge may adjudicate. Additionally, "certain sections of the Bankruptcy Code . . . expressly incorporate state law, which is often different from state to state."
section_title: The Key Players in a Bankruptcy Case
paragraphs: Although many types of people and entities can potentially play critical roles in a bankruptcy proceeding, several participants in the bankruptcy process are particularly important. Perhaps the most important participants are the debtor (who seeks relief from debts he cannot repay) and the creditors (who seek to promptly and efficiently collect as much of their debts as they can).
Of equal importance is the bankruptcy judge , who generally presides over the bankruptcy proceeding; reviews and rules upon filings submitted by participants in the bankruptcy case; resolves certain types of disputes between the parties; and performs other similar duties. The U.S. Courts of Appeals appoint bankruptcy judges to serve "as judicial officers of the United States district court[s] established under Article III of the Constitution" for fourteen-year terms. Unlike U.S. District Judges, however, bankruptcy judges "enjoy neither tenure during good behavior nor salary protection," and therefore do not exercise "the judicial power of the United States" as defined in Article III of the U.S. Constitution. As a consequence, both the U.S. Code and the U.S. Constitution restrict a bankruptcy judge's authority to adjudicate certain matters.
Serving as "an auxiliary to the Bankruptcy Court" is the United States Trustee , who, among other duties, oversees bankruptcy cases in most jurisdictions in order "to prevent fraud, dishonesty, and overreaching in the bankruptcy system." The United States Trustee works "under the general supervision of the Attorney General" of the United States, who "provide[s] general coordination and assistance to the United States trustees."
Not to be confused with the United States Trustee is the case trustee , whose role in the bankruptcy proceeding differs depending on which Chapter of the Bankruptcy Code the bankruptcy case proceeds under. Some Chapters contemplate a major role for the case trustee; other Chapters contemplate that a case trustee will have no role in the proceeding whatsoever absent exceptional circumstances. A case trustee who is appointed in a case under Chapter 7 of the Bankruptcy Code is known as the "Chapter 7 trustee"; a case trustee appointed in a Chapter 13 case is known as the "Chapter 13 trustee," and so forth. This report discusses the case trustee's respective roles under each Chapter below.
section_title: Filing for Bankruptcy
paragraphs: A debtor may declare bankruptcy by filing a document known as a bankruptcy "petition" with the clerk of the bankruptcy court. In addition to the petition, most debtors must also file a schedule of the debtor's assets and liabilities; a schedule of the debtor's current income and expenditures; a statement of the debtor's financial affairs; and other required documents. These filing requirements "are carefully designed to elicit certain information necessary to the proper administration and adjudication of the case" and to "ensure that there is adequate information available to the debtor's creditors" to facilitate the fair and efficient distribution of the debtor's income or assets. Depending on the debtor's financial circumstances, the debtor may also be required to pay a filing fee.
section_title: The Bankruptcy Estate
paragraphs: Filing a petition in the bankruptcy court creates a bankruptcy " estate " that, subject to certain exceptions, is "comprised of the debtor's property as of the commencement of the case." The assets in the bankruptcy estate are generally used "to satisfy claims of creditors and costs of the proceedings."
Importantly, however, certain types of property are either not included in the estate or may otherwise be removed from the reach of creditors. For instance, property that the debtor acquires after filing his bankruptcy petition is, with some exceptions, "generally not property of the estate." Furthermore, the Bankruptcy Code and applicable state law may allow an individual debtor to " exempt " certain categories of assets from the property of the estate and thereby insulate those assets from the claims of creditors. For example, depending on the circumstances, an individual debtor may be able to claim articles of clothing, certain medical equipment, and/or his residence as exempt from the claims of creditors. Permitting an individual debtor to claim certain assets as exempt "allow[s] a debtor to protect property which is necessary for the survival of both the debtor and the debtor's family." Note, however, that a non -individual debtor, such as a corporation or other business entity, may not declare property as exempt.
section_title: The Automatic Stay
paragraphs: Filing for bankruptcy affords the debtor several immediate benefits. Perhaps most importantly, "the filing of a bankruptcy petition stays the commencement or continuation of all nonbankruptcy judicial proceedings against the debtor"; precludes creditors from undertaking "any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case"; and, with certain exceptions, prohibits creditors from taking almost any action "against the debtor or the property of the estate." These protections are collectively known as the " automatic stay ." The stay is "automatic" because "it operates without the necessity for judicial intervention"; it "is triggered upon the filing of a bankruptcy petition regardless of whether the other parties to the stayed proceeding are aware that a petition has been filed." The automatic stay generally remains in effect until the bankruptcy court closes the case, dismisses the case, or grants the debtor a discharge, whichever comes first.
"The policy underlying the automatic stay is to protect the debtor's estate from 'the chaos and wasteful depletion resulting from multifold, uncoordinated and possibly conflicting litigation'" that could occur in the absence of the stay. "The automatic stay provides debtors a breathing spell from creditors by preventing 'all collection efforts, all harassment, and all foreclosure actions.'" "The stay protects creditors, too, by precluding certain 'creditors from acting unilaterally in self-interest to obtain payment from a debtor to the detriment of other creditors.'"
A creditor who knowingly violates the automatic stay—such as by attempting to collect a debt the debtor owes to him —does so at his peril. "An individual injured by any willful violation of" the automatic stay may potentially "recover actual damages" against the violator, "including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages." Thus, if a creditor or other entity subject to the automatic stay wishes to take action against the debtor or his estate, it must usually ask the bankruptcy court to "grant relief from the stay, . . . such as by terminating, annulling, modifying, or conditioning the stay" to allow the creditor to take the requested action. The court may grant relief from the automatic stay "for cause," as may exist when "the hardship to the movant" resulting from the enforcement of the automatic stay would outweigh "the hardship to the debtor" if the automatic stay were lifted, or when the debtor has filed bankruptcy in bad faith solely to prevent an impending foreclosure. Alternatively, the court may also grant relief "with respect to a stay of an act against property" if "the debtor does not have an equity in such property" and "such property is not necessary to an effective reorganization" of the debtor. As a result, a creditor may, for example, be able to successfully obtain relief from the automatic stay when the debtor has failed to make timely mortgage payments. The likelihood that a bankruptcy court will grant a party relief from the automatic stay varies depending on the context.
section_title: Types of Bankruptcy Proceedings
paragraphs: Broadly speaking, "the United States has three methods of declaring bankruptcy: liquidation, reorganization, and adjustment of debts." When filing a bankruptcy petition, the debtor must select which of these methods to utilize by choosing a "Chapter" of the Bankruptcy Code under which to file. The Bankruptcy Code functionally creates a menu of different bankruptcy proceedings that a debtor may potentially utilize:
1. liquidation proceedings under Chapter 7; 2. reorganization proceedings under Chapter 11; 3. the adjustment of debts of an individual with regular income under Chapter 13; 4. the adjustment of debts of a family farmer or fisherman with regular annual income under Chapter 12; 5. the adjustment of debts of a municipality under Chapter 9; and 6. ancillary and cross-border cases under Chapter 15.
As explained in greater detail below, each of these types of proceedings has different eligibility requirements, is governed by different procedures, and results in different forms of relief. Some debtors, depending on their individual characteristics, may be eligible to file bankruptcy under more than one Chapter, and may therefore select whichever form of bankruptcy proceeding would be most advantageous in light of the debtor's particular financial circumstances. Other debtors may be eligible to file only under a single Chapter, and must either file bankruptcy under that Chapter or not file at all. Still other debtors may not be eligible to file for bankruptcy under any Chapter of the Bankruptcy Code whatsoever.
subsections: section_title: Chapter 7 Liquidation
paragraphs: A liquidation proceeding under "Chapter 7 is the most common form of bankruptcy" in the United States. According to statistics published by the United States Courts, approximately half a million debtors file bankruptcy pursuant to Chapter 7 each year. Notable examples of companies that have filed bankruptcy under Chapter 7 include the Bennigan's restaurant chain, IndyMac Bancorp, and Acclaim Entertainment (perhaps best known for porting the "Mortal Kombat" video game to the Sega Genesis and Super Nintendo video game consoles).
"The primary purpose" of Chapter 7 "is to liquidate the [d]ebtor['s] assets in order to satisfy the [d]ebtor['s] creditors." To facilitate this liquidation, the case is administered by a Chapter 7 trustee who, among other responsibilities, "has the general duties of marshalling all available property, reducing it to money, distributing it to creditors, and closing up the estate."
subsections: section_title: Eligibility for Chapter 7 Bankruptcy
paragraphs: Although both individual debtors and non-individual debtors (such as corporations, limited liability companies, and other business entities) may potentially be eligible for Chapter 7 relief, Chapter 7 treats the two types of debtors differently, as explained below.
subsections: section_title: Individual Debtors
paragraphs: Chapter 7 potentially "allows an individual who is overwhelmed by debt to obtain a 'fresh start' in the form of a discharge of most types of debt by surrendering for distribution his or her nonexempt property." However, the Bankruptcy Code limits an individual debtor's ability to obtain Chapter 7 relief by imposing a "means test" to determine whether "an individual debtor . . . whose debts are primarily consumer debts" qualifies for Chapter 7 relief. If the debtor's current monthly income, reduced by certain allowable expenses, exceeds statutory thresholds established by the Bankruptcy Code, then the bankruptcy court must either dismiss the Chapter 7 case or convert the case to a debt adjustment proceeding under Chapter 13. "The primary purpose of the means test in Chapter 7 is to shift consumer debtors into Chapter 13" of the Bankruptcy Code—which this report discusses in greater detail below —when those debtors are able to "pay some or all of their debts in a Chapter 13 plan."
section_title: Non-Individual Debtors
paragraphs: Many (though not all) types of non-individual debtors are, like individual debtors, potentially eligible for Chapter 7 bankruptcy as well. "[I]n a Chapter 7 proceeding involving a business entity, the trustee assumes control of the entity for the purpose of realizing the maximum value that is available for the benefit of the creditors." Also, for reasons explained in greater detail below, some bankruptcy cases filed by non-individual debtors begin as Chapter 11 reorganizations but are subsequently converted to Chapter 7 liquidations.
Unlike an individual debtor, however, a non-individual debtor does not receive a discharge of its outstanding debts at the conclusion of a Chapter 7 liquidation. Congress opted to prohibit non-individual debtors from obtaining a discharge under Chapter 7 in order "to prevent businesses from evading liability by liquidating debtor corporations and resuming business free of debt." "Corporate debt" therefore "survive[s] Chapter 7 proceedings" and is "charged against the corporation when it resume[s] operations." "Despite the inability to obtain a discharge, some corporations" and other business entities nonetheless "choose Chapter 7 bankruptcy because it provides an efficient process by which the corporation may sell off its assets and distribute the proceeds to its creditors." "After filing Chapter 7 bankruptcy, . . . the corporate debtor is usually expected to dissolve because its debts are not 'discharged' and continued business will impact its relationships with creditors."
section_title: Liquidation and Distribution of the Estate
paragraphs: As noted above, in a Chapter 7 liquidation, the case trustee "sells the property of the estate and distributes the proceeds to the debtor's creditors." The Bankruptcy Code establishes a complex hierarchy of expenses and claims that are entitled to payment before others. To name one example, a " secured creditor "—that is, a creditor who has a legal right against certain property (known as " collateral ") that the debtor has pledged as security against the debt in the event the debtor defaults —is generally "entitled to be paid in full out of the proceeds of the collateral before any of those proceeds may be used to pay" any " unsecured creditors " who, "upon giving credit" to a debtor, "take[] no rights against specific property of the debtor." To name another example, claims for specified types of domestic support obligations are entitled to be paid before certain unpaid property taxes.
"Lower priority creditors cannot receive anything until higher priority creditors are paid in full." If, due to a shortfall of assets in the estate, "a priority tier cannot be paid in full," then "distribution is made pro rata among creditors within such tier." If, by contrast, "the estate has enough assets to pay in full all . . . priority claims, distribution will be made pro rata among" creditors in the lower tiers.
section_title: Chapter 11 Reorganization
paragraphs: Whereas the purpose of a Chapter 7 proceeding is to liquidate the debtor, most Chapter 11 proceedings aim to reorganize the debtor's debt structure so that the debtor may continue to operate. A Chapter 11 reorganization "is premised on the concept that the debtor is worth more as a going concern than in liquidation. That is, continuation of the debtor's business will create more value than will dismemberment and piecemeal sale of the assets." Thus, a debtor that aims to emerge from bankruptcy as an operating entity as opposed to shuttering its doors will likely prefer a Chapter 11 reorganization to a Chapter 7 liquidation. Some creditors may likewise prefer that the debtor reorganize under Chapter 11 instead of liquidating under Chapter 7, depending on whether or not they stand to derive a greater economic benefit from the debtor continuing to operate as a going concern than if the debtor were promptly liquidated.
Chapter 11 is "intended primarily for the use of business debtors" such as corporations and limited liability companies. Notable examples of large companies that have filed for bankruptcy under Chapter 11 include Kmart, General Motors, and the Los Angeles Dodgers.
Notwithstanding that Chapter 11 is "intended primarily for the use of business debtors," "individual debtors not engaged in business" may be eligible to "file for relief under Chapter 11" as well. In particular, an individual debtor who is ineligible to file for bankruptcy under Chapter 13 because his outstanding debt exceeds statutory debt limits established by the Bankruptcy Code may instead be able to file under Chapter 11. That said, even though "Chapter 11 is not restricted to business-debtors, business entities file under Chapter 11 far more frequently than individual debtors do."
"The primary goal of Chapter 11" is "to formulate a comprehensive reorganization plan " that adjusts "the rights and obligations among the debtor and its debt- and equityholders . . . so as to render the reorganized debtor a viable economic entity." "The chapter 11 plan becomes a binding contract between the debtor and its creditors, and governs their rights and obligations."
subsections: section_title: The Debtor-In-Possession
paragraphs: Unlike in a Chapter 7 liquidation, in which a trustee administers the debtor's assets in order to satisfy the claims of creditors, a Chapter 11 debtor generally remains in possession of its assets throughout the entire reorganization proceeding "and administers them for the benefit of the creditor body." Congress decided when enacting the Bankruptcy Code that "current management is generally best suited to orchestrate the process of rehabilitation for the benefit of creditors and other interests of the estate," and as a result Chapter 11 typically permits the debtor (rather than a trustee) to remain in control of its assets and operations. When acting in this capacity, the debtor is known as the "debtor-in-possession." Managers of the debtor therefore generally "prefer Chapter 11 to Chapter 7 because Chapter 11 allows them to retain control of the firm as a debtor-in-possession, whereas Chapter 7, by requiring appointment of a trustee, does not."
With some exceptions, the debtor-in-possession may generally enter into transactions and use estate property in the ordinary course of business without first obtaining the bankruptcy court's approval. However, any action the debtor-in-possession takes outside the ordinary course of business typically "requires notice, hearing and court approval" in advance. An action "outside the ordinary course of business" includes any transaction "that might be considered unusual, controversial, or questionable for the debtor to undertake during its Chapter 11 case," like a sale of "substantially all the debtor's assets." The "ordinary course of business" standard provides the debtor-in-possession "the flexibility to engage in ordinary transactions without unnecessary creditor and bankruptcy court oversight, while protecting creditors by giving them an opportunity to be heard when transactions are not ordinary."
section_title: The Chapter 11 Plan
paragraphs: As noted above, "the primary goal of Chapter 11" is "to formulate a comprehensive reorganization plan that will ultimately rehabilitate financially distressed debtors." Ideally, a Chapter 11 plan is a product of negotiation between the debtor and its key stakeholders that adjusts "the rights and obligations among the debtor and its debt- and equityholders . . . so as to render the reorganized debtor a viable economic entity."
The debtor may file a proposed Chapter 11 plan at any time. Although an interested party to the bankruptcy case, such as a creditor, may potentially file a proposed Chapter 11 plan of its own, the Bankruptcy Code circumscribes a non-debtor's ability to propose a Chapter 11 plan in several respects. To name but one example, the Bankruptcy Code establishes an initial exclusivity period during which "only the debtor may file a plan."
Among other requirements, a proposed plan must
divide similarly situated debt-holders and equity-holders into separate "classes." identify which classes will have their claims "impaired" by the plan. "A class is impaired if there is 'any alteration of a creditor's rights, no matter how minor.'" specify how the plan will alter the claims belonging to the impaired classes. treat every entity in a given class the same as other class members (unless a particular claimant agrees to less favorable treatment). provide adequate means for the plan's implementation, such as by allowing the debtor to retain certain property; selling or transferring the debtor's property; satisfying or modifying liens; curing or waiving a default by the debtor; and so forth.
After a party proposes a plan, creditors who are adversely affected by the plan may then vote in favor of or against it. Generally, in order to facilitate the voting process, "a proponent of a plan must also submit a disclosure statement" that gives parties potentially affected by the plan "information sufficient to enable" them "to make an informed judgment . . . as to whether they should vote in favor of the plan." The bankruptcy court will then "fix a time within which" creditors may vote on the plan. Voting creditors must submit their votes in writing to the plan proponent's attorney prior to the deadline established by the court. A class of creditors has accepted—that is, voted in favor of—a proposed plan if "creditors . . . that hold at least two-thirds in amount and more than one-half in number of the allowed claims of such class" have voted in favor of the plan.
After the voting deadline expires, the court must hold a hearing to decide whether the plan shall become effective—that is, whether to " confirm " the plan. A bankruptcy court cannot confirm a proposed Chapter 11 plan unless it satisfies not only the criteria enumerated in the bullet points above, but also several additional prerequisites established by the Bankruptcy Code, the most notable of which are discussed in the subsections that follow.
subsections: section_title: Best Interests of Creditors
paragraphs: For one, "a Chapter 11 reorganization plan may not be confirmed unless it satisfies the 'best interests of creditors' test." "This test requires that each holder of an impaired claim or interest either accept the plan or receive under the plan not less than it would receive in a Chapter 7 liquidation." "This means that, absent consent, a creditor must receive property that has a present value equal to that participant's hypothetical chapter 7 distribution if the debtor were liquidated instead of reorganized on the plan's effective date." As a result, because having, for example, a dollar in hand today is typically more valuable than receiving that same dollar several years from now, "a Chapter 11 plan does not satisfy the best-interests-of-creditors test if the debtor, rather than paying a creditor the amount it would receive in a Chapter 7 liquidation in full on the effective date of the plan, proposes instead to pay that same amount over time." Where, by contrast, impaired creditors would receive nothing in a hypothetical Chapter 7 liquidation, the plan will likely satisfy the best interests of creditors test because a Chapter 11 plan mathematically cannot pay creditors less than zero.
section_title: Feasibility
paragraphs: Additionally, "to be confirmed, every chapter 11 plan must be 'feasible.'" This means that the plan proponent must show that "confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor . . . unless such liquidation or reorganization is proposed in the plan." "The purpose of this feasibility requirement is to prevent confirmation of unrealistic plans which promise creditors and equity security holders more than the debtor can likely attain after confirmation." A plan is infeasible, for example, if it proposes to "keep creditors 'on hold' without receipt of payments while the debtor seeks to sell real estate which it has been unable to sell in years past," as "such plans are nothing more than speculative ventures which place all the risk on the . . . creditors."
section_title: Cramdown
paragraphs: Nor may a bankruptcy court confirm a proposed Chapter 11 plan unless it either (1) satisfies a requirement codified at Section 1129(a)(8) of the Bankruptcy Code that all classes of impaired creditors accept the proposed plan; or (2) satisfies what are called the " cramdown " requirements of Section 1129(b).
"Section 1129(a)(8) can be satisfied only if each class" of creditors "under a proposed plan either has accepted the plan or is not impaired under the plan." Section 1129(a)(8) thereby requires that a proposed plan "be consensual, with unanimous acceptance by all of the impaired classes."
Nevertheless, "the failure to comply with § 1129(a)(8) is not fatal." "A plan that does not satisfy [§] 1129(a)(8) nonetheless can be confirmed" pursuant to Section 1129(b) if the plan "does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." In order for the court to deem a plan "fair and equitable" for cramdown purposes, the plan must satisfy the "absolute priority rule." "That rule requires that, if a class of senior claim-holders will not receive the full value of their claims under the plan and the class does not accept the plan, no junior [claim-holder] may receive 'any property' 'under the plan on account of such junior claim or interest.'" A senior claim-holder is defined as a creditor holding a claim that is entitled to payment before other claims in the hierarchy of distribution to creditors, whereas a junior claim-holder holds a claim that is ranked lower in the hierarchy.
Obtaining confirmation of a plan over the objection of impaired creditors in accordance with Section 1129(b) is known as a "cramdown." Many (though not all) commentators agree that plan proponents utilize the Bankruptcy Code's cramdown provisions relatively infrequently.
section_title: The Effect of Confirmation
paragraphs: A confirmed Chapter 11 plan binds the debtor, the creditors (including creditors who did not vote in favor of the plan), and other parties. "Except as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor." Additionally, the confirmation of a Chapter 11 plan "generally discharges the debtor from its pre-confirmation debt and substitutes the obligations of the plan for the debtor's prior indebtedness." This discharge operates as an injunction that, with some exceptions, prohibits creditors from "commenc[ing] or continu[ing] an action, employ[ing] process, or act[ing], to collect, recover, or offset any debt that was subject to discharge." A creditor who violates the discharge injunction is potentially subject to civil contempt proceedings.
"A confirmed plan creates a new contract between the debtor and interested parties, which replaces pre-petition obligations with a new contractual obligation in accordance with the creditor's treatment under the confirmed plan." Thus, "where a debtor fails to make payments or act in accordance with a confirmed plan, a creditor's remedy may be for breach of contract or suit to enforce the debtor's obligation."
section_title: Chapter 13 Consumer Cases
paragraphs: "Chapter 13 of the Bankruptcy Code is titled 'Adjustment of Debts of an Individual With Regular Income' and is essentially a reorganization that allows the debtor to 'deal comprehensively with'" his debts. "The purpose of Chapter 13 is to enable an individual, under court supervision and protection, to develop and perform under a plan for the repayment of his debts" "in installments over time." "In some cases, the plan will call for full repayment. In others, it may offer creditors a percentage of their claims in full settlement."
A debtor may not file bankruptcy under Chapter 13 unless she is an "individual with regular income" who owes a total amount of debt that does not exceed a maximum debt threshold established by statute. Thus, a non-individual debtor, such as a corporation or limited liability company, may not file for bankruptcy under Chapter 13.
Notably, "in a Chapter 13 case, unlike a Chapter 7 case, the debtor remains in possession of the property of the estate." "Unlike Chapter 7 proceedings, where a debtor's nonexempt assets are sold to pay creditors, Chapter 13 permits debtors to keep assets such as their home and car so long as they . . . comply with their obligations under their confirmed plan of reorganization." "The right to remain in possession of all property of the estate is a major advantage of chapter 13 debtors who would be required to turn over nonexempt property to the trustee in a chapter 7 case." Chapter 13 thereby potentially permits a debtor "to save his or her home from foreclosure by curing a mortgage default and, while continuing to pay the mortgage obligation as installments come due, curing" arrearages that the debtor incurred before he filed bankruptcy "over time." For that reason, debtors who own homes may prefer filing under Chapter 13 (assuming they are eligible to do so) instead of filing under Chapter 7.
Notwithstanding the differences between Chapter 13 and Chapter 7, Chapter 13 cases are similar to Chapter 7 cases to the extent that a case trustee administers both types of proceedings. In many judicial districts, the U.S. Trustee appoints "standing Chapter 13 trustees" who "oversee all Chapter 13 cases filed in " their respective districts. Among other duties, the Chapter 13 trustee
ensures "that the debtor commences making timely payments" that will be distributed to creditors; "Receive[s] monthly payments made by debtors and" distributes "the proceeds to creditors"; and investigates the debtor's financial affairs.
Chapter 13 cases are also similar to Chapter 11 cases to the limited extent that both ideally result in the confirmation of a plan that alters the debtor's relationships with his creditors. Among other requirements, a Chapter 13 plan must propose "to use future income to repay a portion (or in the rare case all) of" the debtor's "debts over the next three to five years." Only the debtor may file a proposed plan under Chapter 13. "Unlike Chapter 11, creditors in a Chapter 13 case are not allowed to vote on a proposed plan," though the Chapter 13 trustee or certain parties with a pecuniary interest in the Chapter 13 case may object to a proposed plan that does not comply with certain requirements established by the Bankruptcy Code. "If an unsecured creditor or the bankruptcy trustee objects to confirmation" of the proposed plan, Chapter 13 "requires the debtor either to pay unsecured creditors in full or pay all 'projected disposable income' to be received by the debtor over the duration of the plan"; otherwise, the "bankruptcy court may not approve the plan." If the proposed plan complies with Chapter 13's requirements, "the court shall confirm" it. "The provisions of a confirmed plan" under Chapter 13 "bind the debtor and each creditor."
Generally speaking, "all payments to creditors must be made through the Chapter 13 trustee." That is, "the Chapter 13 Trustee must collect payments as provided in the plan" from the debtor "and must distribute those payments" to creditors "as provided in the plan." "During the repayment period, creditors may not harass the [d]ebtor or seek to collect their debts. They must receive payments only under the plan."
"With certain exceptions . . . when a chapter 13 debtor completes all payments under a chapter 13 plan, the Court must grant the debtor a discharge of all debts provided for by the plan." Thus, "unlike the chapter 7 discharge, which is typically granted relatively quickly, the chapter 13 debtor must, in most situations, successfully complete all plan payments before they may be granted a discharge."
If, however, the "debtor fails to make timely payments under his plan," the Chapter 13 trustee may (1) ask the court to either (i) dismiss the case or (ii) convert it to a Chapter 7 liquidation; or (2) seek modification of the plan. Dismissal of a Chapter 13 case usually "provide[s] no relief for the debtor, as it generally restores the debtor to the status quo ante." When the court dismisses a debtor's Chapter 13 case, the automatic stay "terminate[s] by operation of law," and the debtor's creditors may once again attempt to collect their outstanding debts to the extent they have not already been paid through the plan.
"Because Chapter 7 provides a quicker discharge of the debtor's obligations" than Chapter 13, many debtors would "typically prefer" to file under Chapter 7 rather than Chapter 13, especially debtors who do not own a home that Chapter 13 could protect. Debtors may also "prefer to file chapter 7 when their debts overwhelmingly outweigh their assets," as Chapter 7 allows debtors to discharge debts without pledging their future income to creditors.
On the other hand, however, "unsecured creditors often receive more money under successful Chapter 13 plans than they would under a Chapter 7 liquidation bankruptcy," and some "policymakers prefer Chapter 13 to Chapter 7 because it includes an acknowledgement by filers to pay as much of their debts as they can, whereas Chapter 7 filers are asking to be relieved of the burden of paying anything towards the debts they have incurred." For those reasons, "an individual debtor . . . whose debts are primarily consumer debts" is ineligible for Chapter 7 relief if his current monthly income, reduced by certain allowable expenses, exceeds statutory thresholds established by the Bankruptcy Code. As mentioned above, this eligibility provision is called the "means test," and it is "designed to force some debtors into chapter 13 when they would prefer chapter 7."
section_title: Chapter 12 Family Farmer/Family Fisherman Cases
paragraphs: Chapter 12 of the Bankruptcy Code offers a form of bankruptcy relief that is "similar to that available" to individual consumers "under chapter 13," but is only available to family farmers and family fishermen with regular annual income. Although Chapter 12 is infrequently utilized, Chapter 12 exists "to give family farmers" and family fishermen "a chance to reorganize their debts and keep their farms while preserving the fair treatment of creditors." To that end, "a Chapter 12 debtor has the right to continue to operate the farm [or fishing] business" during the pendency of the bankruptcy case.
To qualify as a "family farmer" or "family fisherman" within the meaning of Chapter 12, the debtor must satisfy a complicated series of statutory prerequisites. Among other requirements, the debtor's aggregate debt must not exceed certain statutory limits, and a statutorily defined percentage of the debtor's debts must arise out of a farming operation or commercial fishing operation.
"Chapter 12 was modeled on chapter 13," and as a result "many of the provisions" of both Chapters "are identical." Most pertinently, Chapter 12 debtors may "preserve existing assets subject to a 'court-approved plan under which they pay creditors out of their future income'" like Chapter 13 debtors. Nevertheless, "there are significant differences between Chapter 12 and Chapter 13." To name just one example, Chapter 13 "is substantially less permissive than Chapter 12 regarding the scope of allowed modifications of secured debt, particularly regarding modifications of claims secured by residences."
section_title: Chapter 9 Municipality Cases
paragraphs: Chapter 9 of the Bankruptcy Code authorizes certain municipal debtors to restructure their debts so that they may "provide adequate municipal services" to residents. Because municipalities provide essential services to their residents, such as police protection, fire protection, garbage removal, and the like, a "municipality cannot be liquidated, its assets sold, and the proceeds used to pay its creditors." Chapter 9 therefore permits municipalities to adjust their debts pursuant to a confirmed adjustment plan, "which fosters the continuance of municipalities rather than their dissolution."
"The general policy considerations underlying the municipal debt adjustment plan of chapter 9 are the same as that of chapter 11 reorganization: to give the debtor a breathing spell from debt collection efforts and establish a repayment plan with creditors." However, unlike Chapter 11, "the entire structure of chapter 9 has been influenced by th[e] pervasive concern to preserve the niceties of the state-federal relationship." To that end, Chapter 9 restricts the bankruptcy court's ability to "interfere with the political or governmental powers of the petitioner, the property or revenue of the petition, or any income-producing powers" in order to preserve "the sovereignty of the states." Additionally, to avoid further "encroaching on state sovereignty," there is little to no role for a case trustee in a Chapter 9 case.
Although Chapter 9 bankruptcies are presently relatively infrequent, some commentators predict that municipal bankruptcies could potentially become more common in the future "as increasing numbers of cities and towns face fiscal distress." High-profile examples of municipalities that have filed bankruptcy under Chapter 9 include the City of Detroit, Michigan; the City of San Bernardino, California; and Jefferson County, Alabama.
section_title: Chapter 15 Ancillary and Cross-Border Cases
paragraphs: Chapter 15 of the Bankruptcy Code "was enacted by Congress . . . as a means to facilitate international cooperation in the administration of cross-border insolvencies" and to "incorporate the Model Law on Cross-Border Insolvency . . . promulgated by the United States Commission on International Trade Law." Chapter 15 "authorizes an 'ancillary' proceeding in a United States bankruptcy court that is largely designed to complement and assist a foreign insolvency proceeding by, among other things, 'bringing people and property beyond the foreign main proceeding's jurisdiction into the foreign main proceeding through the exercise of the United States' jurisdiction." "Filings under Chapter 15" are "relatively infrequent."
section_title: Conversion to Another Chapter
paragraphs: Under certain circumstances, a bankruptcy court may convert a case commenced under one Chapter of the Bankruptcy Code to a case under another Chapter. For example, if a Chapter 11 debtor engages in "gross mismanagement of the estate," the bankruptcy court may convert the case to a Chapter 7 liquidation and thereby place the debtor's assets under the control of a Chapter 7 trustee to "liquidate the property so as to maximize distribution to creditors of the estate." Similarly, "a chapter 13 debtor who is unable to complete plan payments may request that the case be converted to Chapter 7."
section_title: Discharge
paragraphs: As noted above, most types of bankruptcy cases ideally culminate in a " discharge " of many of the debtor's preexisting debts. Generally speaking, a discharge
"Voids any judgment . . . to the extent that such judgment is a determination of the personal liability of the debtor with respect to" the discharged debt; and "Operates as an injunction against the commencement or continuation of" any "action" or "act to collect or recover" the discharged debt.
A creditor who "attempt[s] to collect on a debt that has been discharged in a bankruptcy proceeding" may potentially be "punished by contempt of court."
subsections: section_title: Exceptions and Limitations to Dischargeability
paragraphs: Although most debts that arise prior to the date on which the debtor filed his petition are typically dischargeable in bankruptcy, "Congress has decided" that, in some circumstances, "public policy considerations override the need to provide the debtor with a fresh start." The Bankruptcy Code accordingly specifies certain categories of debts that are presumptively or categorically nondischargeable in bankruptcy. For instance:
A debtor may not discharge a debt "for death or personal injury caused by the debtor's operation of a motor vehicle, vessel, or aircraft if such operation was unlawful because the debtor was intoxicated from using alcohol, a drug, or another substance." Nor may a debtor discharge "a domestic support obligation." A Chapter 7 debtor may not discharge a debt "for willful and malicious injury by the debtor to another entity or to the property of another entity." A debtor may not discharge a student loan "unless excepting such debt from discharge . . . would impose an undue hardship on the debtor and the debtor's dependents."
Also, as a general matter, a discharge order does not discharge claims against the debtor that arise after the debtor filed his bankruptcy petition. Furthermore, with some exceptions, liens against the debtor's property generally "continue in effect despite the entry of a bankruptcy discharge, which discharges only a debtor's personal liability on an unpaid debt."
Additionally, under certain circumstances, a bankruptcy court may deny a discharge to a debtor who might otherwise be eligible to receive one. For instance, a bankruptcy court may deny a discharge to certain debtors who commit misconduct during the bankruptcy case or otherwise fail to comply with certain requirements of the Bankruptcy Code. A debtor who files bankruptcy a second time too soon after receiving a discharge in an earlier bankruptcy case may likewise be ineligible for a discharge.
Appendix A. Glossary
Appendix B. Table Illustrating Differences Between Chapters of the Bankruptcy Code