Bankruptcy 101: “Talk the Talk”
At the risk of having my club membership rights revoked by my bankruptcy attorney colleagues, I thought that it might be helpful in my first column in Attorney at Law to explain a bit about our “secret language.” Like many specialized areas, bankruptcy law has its own vernacular, an understanding of which goes a long way toward understanding the process and its effects. In future columns, I’ll begin unraveling the mysteries of both consumer and business bankruptcies and discussing how a bankruptcy affects the interests of the parties involved.
The Bankruptcy Code
Our current system of bankruptcy was enacted in 1978, and is governed by the Bankruptcy Code (11 U.S.C. §§ 101-1532). The Bankruptcy Code is divided into nine chapters, certain of which contain the provisions that relate solely to the eponymous types of bankruptcies with which most people are familiar: Chapters 7, 11 and 13. There also are special (and somewhat obscure) types of bankruptcy cases for insolvent municipalities (Chapter 9), family farmers and fishermen (Chapter 12), and cross-border insolvency matters (Chapter 15). The first three chapters cover other procedural and substantive areas that apply to most if not all of the different types of bankruptcy, and are titled “General Provisions” (Chapter 1), “Case Administration” (Chapter 3), and “Creditors, Debtor and Estate” (Chapter 5). Oddly, the Bankruptcy Code does not contain chapters 2, 4, 6, 8, 10 or 14. Welcome to the intuitive world of bankruptcy!
The Debtor, simply put, is the party in bankruptcy. Debtors can be natural persons or a wide variety of business organizations.
The Petition Petition Date
Bankruptcy cases are commenced by filing a “petition for relief”, and the date that the petition is filed is called [drumroll, please] the “petition date”. The petition seeks the entry of an “order for relief” which simply means that the protections of bankruptcy have been granted. In a voluntary case the order for relief is automatic and deemed to have been entered on the petition date; in an involuntary case, a debtor can contest whether an order for relief should be entered; if it is, the order is deemed also to have been entered on the petition date.
The bankruptcy estate is a legal fiction that arises on the petition date and comprises all of the debtor’s legal and equitable interests in non-exempt property (tangible and intangible), and certain legal rights or causes of action that arise from the filing of the bankruptcy. In an individual Chapter 7 case, the estate does not include future income or (generally) property acquired after the petition date. In both Chapter 11 and 13 cases, the estate generally includes these assets excepted from the estate in Chapter 7.
The Automatic Stay and Stay Relief
With limited exceptions, the filing of a petition imposes a stay of any action to enforce debts of, file or continue non-bankruptcy litigation against, or exercise control over property of, the debtor. This “King’s X” is one of the primary reasons why many debtors file bankruptcy petitions—to stop foreclosures, enforcement of judgments, collection efforts, and termination of contracts and leases. In order for a creditor to start or continue any of the foregoing actions, they must ask the bankruptcy court—through a motion— for relief from the automatic stay. Colloquially, this is referred to as seeking “stay relief”.
Schedules of Assets Liabilities and Statement of Financial Affairs
The so-called “schedules” and “SOFA” or “statement” are form-based documents required to be filed by every debtor very early in their bankruptcy case. They provide lists of real property and personal property assets, secured and unsecured liabilities, and other useful and comprehensive information about the debtor, its current situation and some history of its transactions with third parties.
Chapter 7 Liquidation
A Chapter 7 bankruptcy case can be filed by a flesh-and-blood person or a business organization. It is a proceeding to liquidate the debtor’s estate and to distribute the proceeds thereof to creditors according to the absolute priority rule (see below). A trustee is always appointed—automatically by the United States Trustee’s office—when a Chapter 7 case is commenced. Notwithstanding the liquidation purpose of Chapter 7, businesses can continue to be run by the Chapter 7 trustee briefly in order to facilitate a sale of the assets as a going concern.
Chapter 11 Reorganization
A Chapter 11 bankruptcy case also can be filed by a flesh-and-blood person or a business organization. It is intended to accomplish a reorganization of the debtor’s affairs, but Chapter 11 cases commonly also involve orderly liquidations, which are referred to as “liquidating 11s”. Go figure. Although a Chapter 11 case may be converted to a Chapter 7, the goal and ultimate result of a Chapter 11 case is a confirmed (court-approved) Chapter 11 plan of reorganization.
Chapter 13 Debt Adjustment
A Chapter 13 bankruptcy can only be filed by a flesh-and-blood person with a regular income, and historically has been called a “wage earner’s case”. In a Chapter 13, a trustee is appointed to oversee the debtor’s performance under a Chapter 13 plan, which typically calls for the debtor to make payments of disposable income to the trustee for 5 years, which the trustee in turn distributes pro rata to creditors.