Bankruptcy

1
Bankruptcy
You cannot engage in transactions effectively
without understanding the extent of and limits on
bankruptcy rights in the United
States. Bankruptcy can end an otherwise
enforceable obligation, but there are limits to
when, how and what it can do.
OBE 118, Section 3, Fall 2004

• Professor McKinsey

2
Bankruptcy

• Can terminate an otherwise legitimate collectible
  debt or owed obligation under a contract.
• Courts do this to allow individuals (people or
  artificial entities) to start over again by
  paying a limited price (but painful) to creditors
  according to a priority list.
• Different types bankruptcy have different effects

3
Types of Bankruptcy

• Liquidation (7) versus Reorganization (11 or 13)
• Voluntary versus Involuntary
• Individuals versus Business Entities

4
Special Rules

• Payments to creditors in last 90 days before BK
  are limited to what creditor would have gotten in
  BK.
• Fraudulent transfers in previous year are
  invalid.
• Six years required after Chapter 7 or 11 before
  Chapter 7 allowed.
• Debtor can reaffirm a debt that would have
  otherwise have been discharged.
• Creditors can seek reaffirmation (and should
  whenever possible)

5
Special Rules Priority

• Secured Creditors have highest priority to extend
  of value of secured property
• Priority Creditors are paid next
• Unsecured Creditors get last feeding at the BK
  trough.

6
Special Rules Debts not Discharged

• Student loans
• Alimony and child support debt
• Credit Card Cash Advances in last 60 days
• Fraudulent money acquisitions

7
Chapter 7- Liquidation

• Petition
• Involuntary - gt10k in unsecured claims, 3 of 12
  or 1 of 11 creditors, and not paying debts that
  are due
• Creditors stopped from collecting
• Debtor- Creditor Meeting
• Proofs of Claims by Creditors
• BK Estate Figured Out and Divided Up
• Exempt property stays with debtor
• The rest is paid out to creditors
• Secured property first to secured creditors
• Priority claims paid next
• Unsecured claims paid last.
• Debtor is Discharged

8
Chapter 11- Reorganization

• No Trustee because debtor keeps operating
• Creditors Committee (7 largest creditors)
• Reorganization plan
• How debts will be paid and when, how business
  will operate
• Majority of creditors in each class must vote for
  it or it must be a cramdown by court
• Discharge
• Only some of the debt is discharged.
• Some is paid by some of the existing assets
• Most debts have new right to a stream of income
  that will cover remainder

9
Chapter 13- Consumer Reorganization

• Only consumers with certain debts maximums
• Only voluntary
• Consumers Payment Plan
• Secured and Priority paid in full
• Unsecured must do at least as well as under
  Chapter 7
• Discharge
• Debts are discharged per plan (only temporarily
  if debtor violates the plan)

10
Advice

• Always be a secured creditor whenever possible,
  and ensure you have adequate collateral
• When debtor looks like trouble coming and you are
  an Unsecured Creditor, consider taking cents on
  the dollar quickly hoping that debtor makes it 90
  days.
• Require cash for services prior to work with
  small or troubled companies.
• Dont go let a single business dominate your
  income picture during any quarter, diversify
  among many clients.